Several major companies have filed for bankruptcy recently, sending their stock prices tumbling. Are they worthwhile speculations? Perhaps, but the risks are great. For less upside potential but also lower risks you could buy the bonds rather than the stocks of bankrupt companies. There is substantial money to be made: if you buy those bonds at 30 cents on the dollar and the bondholders eventually receive 60 cents, you’ll double your money. In a bankruptcy, bondholders must be paid before stockholders.
Buying the bonds is safer than buying the stocks but there are still plenty of risks. Thus, you may want to buy distressed securities through a mutual fund. Among the funds known to invest in such securities is Third Avenue Value Fund, a five-star Morningstar fund that buys both stocks and bonds perceived to be “deep values,” including bankrupt securities. Previous to 2002, the fund had not had a down year since 1994; its 10-year return is around 15.5 percent a year, among the top 3 percent of all mutual funds.
Another fund that buys the bonds of distressed companies is UAM FP Crescent, which had an outstanding year in 2001 (up 36 percent) and has managed to gain again in 2002, no small feat. Fidelity Capital & Income and Mutual Shares are two other established funds that will buy these types of securities.
