Vulture funds are mutual funds which invest in properties, businesses, or sovereign debts that are performing very badly. Many of these funds are undervalued. Vulture funds are a subset of hedge funds. We refer to these investments – which are considered in default or extremely weak – as distressed securities. If the investment is a property, we call it a distressed property.
If a debtor defaults, it means they were unable to (or did not) pay back a debt. A debtor is a person, company, organization, or any entity that owes money.
We call somebody or an organization that buys financial instruments at knock down prices from distressed countries, businesses, and other entities a vulture investor.
Put simply, a vulture fund acquires distressed debt at steep discounts on the secondary market, typically targeting issuers with a high likelihood of default. The strategy of a vulture fund often involves pursuing legal action to recover the full value of the debt, aiming to generate substantial returns despite the elevated risk.
Vulture funds operate in the secondary market
Vulture funds purchase risky debt instruments in the secondary market at knock-down prices. The secondary market is where previously issued financial instruments such as bonds and stocks are sold. It contrasts with the primary market, where new securities are sold.
The fund benefits by taking the original issuers of the financial instruments to court to recover the debt.
This type of mutual fund focuses on fixed income instruments, including high yield bonds. It also targets equities that are either in bankruptcy or nearly bankrupt.
Vulture funds – examples
The Argentinian debt crisis
In February 2016, after negotiating for fifteen years, Argentina agreed to repay six vulture funds. They had bought instruments in the form of Argentinian sovereign debt.
The bondholders – including Aurelius Capital Management, and Elliott Management’s NML Capital unit – were eventually paid $6.5 billion.
The Puerto Rican debt crisis
Puerto Rico, an unincorporated territory of the United States, found finds itself in a similar situation a few years ago. Its government filed for bankruptcy. At the time it owed more than $75 billion in pension and bond debt to its creditors.
Most of the creditors were US hedge fund and mutual fund managers, including Aurelius Capital Management, Franklin, and Oppenheimer.
On June 16, 2019, Puerto Rico’s financial oversight board announced a major breakthrough in its debt restructuring efforts, reaching an agreement with creditors holding roughly $35 billion in bonds (nearly half of the island’s total bonded debt).
The proposed deal, forming part of the framework for the territory’s plan of adjustment, includes significant reductions: an average haircut exceeding 60% across the $35 billion, with pre-2012 general obligation bonds facing a 36% cut and public authority bonds backed by constitutional guarantees seeing a 27% reduction.