Question

1. Why might some hedge fund managers feel they have an edge in trading the defaulted debt of bankrupt companies?

2. Describe what types of situations are most likely to exhibit potential overlap of the hedge fund and private equity industry and why this occurs.

Answer 1

1) Some Hedge fund managers feel that they have an edge in trading the defaulted debt of bankrupt companies. The basic reason behind this action is the theory of 'more risk more returns'. The investors normally expect high default risk associated with thehe companies which have filed for bankruptcy. In this situation, the bonds maybbe available at a very high discount to the face value. So, it becomes a very good purchase at cheaper rate. But in some cases, these companies may have a proper turn around and become viable companies. If this arises, then the hedge funds can sell the bonds at a very high price compared to the purchase price and make quick and high return. Some hedge fund managers are having the expertise to analyse the distressed companies which can become viable in short run. So, they identify such companies and invest.

2) There are a few situations wherein we can see a kind of overlap of hedge funds and private equity investments. Traditionally, hedge funds were focussing on short term and private equity on long term. We might have observed the overlap in a few situations like auctions for mergers, acquisition and take over of companies. The major reasons for this emerging trend is that the tremendous increase in the number of Hedge funds acroos the world compared to that of private equity firms. The number of hedge fund firms are almost three times that of orivate equity firms. Also the capital base for hedge funds also very high because of the open ended nature of the investment. An investor can invest or redeem at any time from a hedge fund, whereas itis closed end nature in the case of private equity. Nowadays, hedge funds firms have experience and expertise to manage funds with long term focus as well. These are the reasons we could see for the overlap of hedge funds and private equity firms in certain situations.