Financial advisors are understandably seeking to stay ahead of the largest transfer of wealth from one generation to the next in our country’s history. According to Cerulli, $72.6 trillion in assets will be passed down from parents to children and other heirs through 2045. Advisors will need to establish and strengthen relationships with clients’ next-generation beneficiaries to ensure that wealth stays under their management.
But there is another huge opportunity for advisors involving the next generation of investors. This one hasn’t received as much attention as the great wealth transfer, but it can create a lot more wealth that can be passed down from generation to generation. I’m talking about the distressed corporate debt bubble.
As of December 7, 2023, Corporate America accumulated $13.7 trillion in debt, with corporate bonds accounting for $7.4 trillion (or 54%), according to the Federal Reserve. Indebted, over-levered companies that issued loans to investors and banks two years ago, when post-pandemic interest rates were considerably lower than today’s, will continue to be pushed toward bankruptcy. JPMorgan credit research found that 41 U.S. companies defaulted, and 47 completed distressed debt exchanges, last year—and the $25.4 billion in distressed bond exchanges in 2023 was the highest total in any calendar year since 2008 ($36.4 billion), during the financial crisis.
Furthermore, JPMorgan reported that 2023 witnessed $58.3 billion in corporate defaults on bonds, and $25.4 billion in distressed bond issuance. The combined total ($83.7 billion) not only represents a 75% year-over-year increase from 2022, but also constitutes the fourth largest annual total ever on record!
During the first quarter of 2024, S&P Global Market Intelligence recorded 142 U.S. corporate bankruptcy filings. And the distress is only going to get worse; the Administrative Office of the U.S. Courts found that business bankruptcy filings rose by 40.4% year-over-year between March 2023 and March 2024.
There’s A Bubble Out There
With interest rates having climbed back up to over 5% from nearly 0%, where they had sunk to approximately 24 months ago in the wake of the pandemic, all the corporate debt borrowed along the way has built the foundation for an unbelievably robust distressed debt cycle. In Darwinian fashion, companies with can’t survive under the weight of their current debt structures will need to offload their debt, or else.
Federal Reserve Chairman Jerome Powell stated on May 1, 2024, that interest rates will stay at their present two-decade high for longer, until he and his colleagues are more confident that inflation is declining to their 2% target. In addition, more and more corporate borrowers who are now over-levered will also suffer distress due to secular trends like inflation, supply chain disruption, and new ways of doing business in their respective industries. Whether it’s old-line telephone companies being displaced by wireless businesses, movie theatre chains being disrupted by the capability to stream movies in the comfort of your own home, Netflix making Blockbuster obsolete, supermarkets being challenged by delivery services, or automobile companies eager to roll out new electric vehicles, the Darwinian evolution of industries makes it impossible for businesses that don’t adapt to survive.
For the present generation of investors, this is a once-in-a-lifetime opportunity to capitalize on the enormous amount of distressed debt in the marketplace right now. Distressed debt investing is a highly specialized area, but advisors who possess this expertise can provide significant value for investors who are eager to obtain healthy returns during this time.
Many of history’s greatest fortunes were acquired through investing in distressed assets. One of the best-known examples of this phenomenon is John D. Rockefeller, whose Standard Oil empire grew to control nearly all of the world’s oil refineries, and a fifth of global oil production. Rockefeller was able to buy rival oil refineries for literally pennies on the dollar when they accumulated debt during up cycles that they couldn’t pay back during down cycles.
I’m not saying that distressed debt investing will turn advisors’ clients into John D. Rockefellers, but they can reap very lucrative returns from an alternative, diversified source of income nevertheless.
During the more than 25 years I have been a vulture investor, I have noted that investors who successfully seek out distressed debt and assets are active investors who undertake diligent research on company and industry fundamentals. Advisors capable of digging through that research to figure out where the chips are going to land—and have clients who are flexible enough to be able to invest in stocks as well as corporate bonds and loans trading at cheap prices—can enrich their clients with non-correlated returns. They can also enrich their practices with more assets under management and a long-term differentiating value for clients.
Now is the time for advisors to begin helping clients invest in distressed debt, or even just short-sell shares of companies that are in distress or unable to adapt to secular industry change. Don’t let this once-in-a-lifetime opportunity to reap returns from today’s exceptionally robust distress cycle.
George J. Schultze is founder of Schultze Asset Management, LP, which focuses on special situation investing in financially troubled and distressed companies.