Tough markets could be good news for capital
By Josh Friedlander
Once upon a time, when distressed companies
used to go bankrupt, hedge funds could engage profitably in at
least one flavor of a tidy strategy known as capital structure
arbitrage. If a company looked near insolvency, funds could buy
the debt and short the stock, with the notion that, in a
restructuring, the senior debt holders would recover most of
their money while equity holders would get the shaft.
Since the recent heyday of capital structure arbitrage, in
2002, cheap money has flooded the markets. This excess
liquidity fueled a buyout boom and meant that faltering
companies were more likely to visit a private equity firm than
a courtroom. Meanwhile, default rates plunged - from a high of
13% to 0.25% today - as did opportunities to short stocks and
go long bonds, one of the more...