Distressed corporate debt represents an excellent opportunity for investors as political and economic uncertainty rattles global bond markets and small and medium sized businesses struggle to raise capital, Jon Macintosh, manager at closed-ended investment company Acencia Debt Strategies told CNBC.
"It all comes back to a huge amount of credit that has been created in the last five or six years largely by the private equity industry funding small and medium sized businesses, where the amount of debt that they've managed to borrow to buy these companies now in hindsight appears to be way too much relative to what those companies can bear," Macintosh said.
Macintosh said the largest gains for investors were in middle market debt, as original lenders panicked and sold company debt at depressed prices.
He explained that Acencia , which has been the best performing listed fund of hedge funds on the London Stock Exchange for the last two years, "rehabilitated" the debt-ridden company through a default at the expense of the initial shareholders.
"We buy that debt cheaply and then shepherd the company through the bankruptcy and it's a little bit like Betty Ford – it’s like a rehab process for an over-geared company.
"You take it, you shepherd it through and bring it out the other side debt free because you swap the debt for the equity of the company and the original shareholders effectively lose out, but the company comes out better and stronger as a result," he said.
Macintosh stressed that the problem was not usually with the company itself, but with the amount it had borrowed and Acencia invested in distressed debt with a clear mantra: "Good company, bad balance sheet."
"The kind of company you're looking for, an ideal candidate is one where you've got a stable, possibly boring, cash generative business which has just borrowed too much money and so its problems are with its balance sheet not with its actual operations or its business," he explained.
Next Step of 'Default Cycle'
Macintosh said he believes the amount of defaults over the next year will increase significantly after a period of low default rates.
The most recent spike was in 2009, when most defaults were confined to the financial services sector.
"What you will see later this year and into the next year is the second leg of the twin peaks of this default cycle where the maturities from these loans start to bite," he said.
"Distressed debt and defaults and the credit market, it's a cyclical industry and so every ten years or so you get a default cycle, once every 60 or 70 years you get what I would call a super cycle and we're halfway through a super cycle right now," he added.
Macintosh said that although he believes the financial crisis to be largely over, the European banking crisis, the structured credit world and the real estate world will all peak at different times and he believes default rates will return to 16 percent by 2013 from the current level of around 2 percent.
"This time around it's broad based and so each sub cycle within the huge super cycle is working on its own timeframe," he added.
He explained that large endowment funds were already looking to take advantage of the next round of defaults.
"Harvard Endowment, Yale Endowment, very rich families in the States, they are all queuing up to invest in the distressed debt space," he said.
Macintosh added that although banks were reluctant to mark down so-called 'zombie companies', he was looking forward to them defaulting at some point.
"We try to make money through as many different opportunities as we can, we're not trying to bet the farm on one area, so those zombie companies, they're still getting by at the moment because interest rates are still zero and their repayments haven't kicked in, but for sure that's going to be tomorrow or the day after's feast."