Searching for risers among the rubble

David Corbin, who heads the Corbin Small Cap Value Fund, laughs when he says he likes to "search through the rubble." What he often finds are distressed firms that present special opportunities for investors.

Case-in-point: VTEL Corp., a developer of videoconferencing technology in Austin, Texas. Its stock was down to about $1 a share. But Mr. Corbin found that the company had cash receivables worth about $1.50 a share. Its sales were down, but VTEL had no debt. A troubled firm with "a promising future," reckons Corbin. "Behind every distressed security, there is a story."

Stocks of companies deep in debt, on the brink of failure, or, less drastically, facing organizational or cash-flow problems present interesting opportunities for investors, according to the folks who track them.

And investors have plenty of choices. The total value of corporate debt defaults for the first quarter of this year (about $33 billion), is more than the total value of defaults in all of 2000. The number of distressed firms "is now higher than at any time since the recession of the early 1990s," says George Siguler, managing director of Siguler Guff & Co., an investment firm with more than $1.8 billion in assets under management.

A decade or so ago, the term "distressed securities" was unheard of. Troubled firms were often referred to as "fallen angels." But many angels took wing, rising with the booming market of the mid-to-late 1990s.

Now, they're back. Many firms, including some of the brightest names in US industry, such as Xerox, Pacific Gas & Electric, Lucent, and the "whole area of telecommunications," says Mr. Siguler, have gotten into trouble.

Siguler, for his part, looks for firms that offer special investment opportunities to institutional investors. Many of these firms are either in, or about to enter, bankruptcy.

"The timing is now right" to invest in distressed securities, Siguler says. Returns from distressed securities will generate annual returns of 10 percent or higher in the months ahead, he predicts.

Siguler Guff (Paine Webber's private-equity group before it went independent) is creating a private-equity fund aimed at high-net-worth individuals and institutions. It will invest in various types of distressed securities, mainly in the debt arena.

Some 300 firms now buy or sell distressed securities. Many specialize in "risk arbitrage," involving exotic hedging strategies.

But such strategies are mainly for sophisticated investors. For most small investors, the best way to get into the distressed sector is through mutual funds, Siguler says.

Information firm Morningstar Inc., in Chicago, counts 193 funds that have more than 5 percent of their net assets in distressed securities. As a group, the funds have done far better than the market this year, down only 3.3 percent though July 23 compared to a 9.2 percent drop in the Standard & Poor's 500 Index.

In fact, 1,519 funds, according to Morningstar, hold at least one distressed security. Most are small-cap and mid-cap value funds, although some are large-cap and growth funds. This overall group is down 7.3 percent though July 23.

Some of these funds, however, are up sharply, with dozens posting returns in the 10 percent to 20 percent range this year.

"We love trouble," says Warren Isabelle, portfolio manager of the ICM-Isabelle Small Cap Value Fund, which is up 17.5 percent through July 23.

Mr. Isabelle avoids firms deep in debt and teetering on the edge of bankruptcy. But he looks for firms "going through difficulties." In other words, he wants firms that "offer the prospect of a turnaround." He also sees more and more firms shifting into trouble in the months ahead.

"No one has a real feel for the economy right now," Isabelle says. "Interest rates are about as good as they are going to get. But despite that, banks are reluctant to lend" to troubled companies.

Firms that he likes include Commonwealth Industries, based in North Carolina, and Graphic Packaging Corp. in Golden, Colo.

Commonwealth is a troubled aluminum fabricator, but with a strong cash-flow position, says Isabelle. Graphic "was on the brink of bankruptcy last year, but has gotten back to a solid footing," he says.

In looking for a mutual fund that specializes in distressed securities, experts stress three basic guidelines:

* Diversification: Make certain the fund owns firms from different economic sectors.

* Stability: Even though the fund owns troubled firms, it should also hold some financially sound firms to offset volatility in the fallen-angel arena.

* Returns: The fund should have a track record of steady gains during both up and down stock markets.

(c) Copyright 2001. The Christian Science Monitor

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