Vulture fund
Encyclopedia
A vulture fund is a private equity
or hedge fund
that invests in debt
issued by an entity that is considered to be very weak or dying, or whose debt is in imminent default
. The name is a metaphor
comparing these investors to vulture
s patiently circling, waiting to pick over the remains of a rapidly weakening company or, in the case of sovereign debt, debtor country. Market practitioners prefer to refer to them as distressed debt or special situations funds.
Vulture funds focused on debt target not only corporate obligers, but also sovereign debtor states. In the recent case of Argentina
, for example, vulture funds bought up a significant portion of the country's external public debt at very low prices (sometimes only 20% of their nominal value), and then attempted to cash them when the Argentine economic crisis
resulted in the bonds' default in January 2002. A single vulture fund run by Kenneth Dart, heir to the Dart Container
fortune, claimed 700 million USD
in a lawsuit against the government of Argentina. Argentine investors were behind many of the secondary market purchases, however. Some estimate that in the debt exchange of 2005
, Argentine bondholders controlled over half of the debt tendered. The reduction in principal
that resulted from the restructuring led a significant minority of bondholders, including Dart, to become holdouts
.
Vulture funds have sometimes had success in bringing attachment and recovery actions against sovereign debtor governments, usually settling with them before actually realizing the attachments in forced sales. In one instance involving Peru, such a seizure threatened payments to other creditors of the sovereign obliger. Settlements typically are made at a discount in hard or local currency or in the form of new debt issuance. A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization. A prime example in the U.S. is K-Mart, where the real estate
held by the company was the anticipated payout for investors who bought stock during their bankruptcy proceedings.
ing on commercial creditors with impunity. Accordingly sovereign debt collection actions began in the 1950s. One example was the freezing of Brazil's gold reserves held by the Federal Reserve.
Investment in sovereign debt with the intent to recover was also restricted due to the laws of champerty and maintenance
and by the fact that most sovereign debt was syndicated. Under the doctrine of champerty, it was illegal in England and the United States to purchase a debt with the sole intent of litigating it. The distinction was made that if the debt was purchased to effect a recovery or facilitate investment, the doctrine was not a bar. Most jurisdictions have now eliminated the doctrine as archaic.
Similarly, sovereign debt owed to commercial creditors in the late 1980s was principally held by bank syndicates. This was the result of the petrodollar
crisis of the 1970s when oil earnings were recycled into bank loans. The syndication of debt among banks made recovery impractical as a fund intending to litigate had to buy out the entire syndicate of holders or risk having the proceeds of litigation attached pursuant to sharing clauses in the loan agreements.
As the 1980s progressed, debt rescheduling efforts in Latin America created many new and easily traded instruments such as Brady bonds
that brought new players into the market, including banks and hedge funds. The original creditors then wrote down their positions and sold the debt into the secondary market, a market consisting of banks and investment funds focused on buying at discounts to achieve above market returns on their investment.
In this process, much debt was repurchased and converted into local currency by the sovereign country issuers in official debt conversion programs designed to attract investment and in severely indebted countries through World Bank
funded buy-backs. The result is that the old syndicates were broken up and many unrestructured syndicate "tails" were available for purchase at discounts exceeding 80% of principal face value. That pricing encouraged funds to invest in recovery actions, which would not otherwise make financial sense due to their length and cost.
In 2011, the UK made permanent the Debt Relief (Developing Countries) Act 2010, which severely restricts the activities of vulture funds in mainland UK, although there are still havens for this activity, such as Jersey and The British Virgin Isles.
Vulture Fund FG Hemisphere run by financier Peter Grossman is trying to claim debt of $100m from the Democratic Republic of Congo, based on an initial loan of £3.3m he purchased from Bosnia's former Prime Minister Nedzad Brankovic
(although the legality of this purchase has been brought into doubt by the Bosnian financial police). Grossman had previously tried to seize the DRC's Washington Embassy as down payment on the debt, but this was blocked by US authorities. His company tried to claim the debt once more in the US, and again in Hong Kong, before attempting to in the Jersey courts. The collection of this debt has been condemned by Unicef, saying that the money could be spent in saving 200,000 infant lives. When questioned whether he thought that his collection of the debt was fair, Grossman replied, "Yeah, I do, actually." Adding, "I am not doing anything wrong. I am collecting a legitimate debt."
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
or hedge fund
Hedge fund
A hedge fund is a private pool of capital actively managed by an investment adviser. Hedge funds are only open for investment to a limited number of accredited or qualified investors who meet criteria set by regulators. These investors can be institutions, such as pension funds, university...
that invests in debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
issued by an entity that is considered to be very weak or dying, or whose debt is in imminent default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
. The name is a metaphor
Metaphor
A metaphor is a literary figure of speech that uses an image, story or tangible thing to represent a less tangible thing or some intangible quality or idea; e.g., "Her eyes were glistening jewels." Metaphor may also be used for any rhetorical figures of speech that achieve their effects via...
comparing these investors to vulture
Vulture
Vulture is the name given to two groups of convergently evolved scavenging birds, the New World Vultures including the well-known Californian and Andean Condors, and the Old World Vultures including the birds which are seen scavenging on carcasses of dead animals on African plains...
s patiently circling, waiting to pick over the remains of a rapidly weakening company or, in the case of sovereign debt, debtor country. Market practitioners prefer to refer to them as distressed debt or special situations funds.
Vulture funds focused on debt target not only corporate obligers, but also sovereign debtor states. In the recent case of Argentina
Argentina
Argentina , officially the Argentine Republic , is the second largest country in South America by land area, after Brazil. It is constituted as a federation of 23 provinces and an autonomous city, Buenos Aires...
, for example, vulture funds bought up a significant portion of the country's external public debt at very low prices (sometimes only 20% of their nominal value), and then attempted to cash them when the Argentine economic crisis
Argentine economic crisis (1999-2002)
The Argentine economic crisis was a financial situation, tied to poilitical unrest, that affected Argentina's economy during the late 1990s and early 2000s...
resulted in the bonds' default in January 2002. A single vulture fund run by Kenneth Dart, heir to the Dart Container
Dart Container
Dart Container Corporation of Mason, Michigan, United States is the world's largest manufacturer of foam cups and containers, producing about as many as all competitors combined.-Company history:...
fortune, claimed 700 million USD
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
in a lawsuit against the government of Argentina. Argentine investors were behind many of the secondary market purchases, however. Some estimate that in the debt exchange of 2005
Argentine debt restructuring
Argentina went through an economic crisis beginning in the mid-1990s, with full recession between 1999 and 2002; though it is debatable whether this crisis has ended, the situation has been more stable, and improving, since 2003....
, Argentine bondholders controlled over half of the debt tendered. The reduction in principal
Haircut (finance)
In finance, a haircut is a percentage that is subtracted from the market value of an asset that is being used as collateral. The size of the haircut reflects the perceived risk associated with holding the asset...
that resulted from the restructuring led a significant minority of bondholders, including Dart, to become holdouts
Holdout problem
In finance, a holdout problem occurs when a bond issuer is in default or nears default, and launches an exchange offer in an attempt to restructure debt held by existing bond holders...
.
Vulture funds have sometimes had success in bringing attachment and recovery actions against sovereign debtor governments, usually settling with them before actually realizing the attachments in forced sales. In one instance involving Peru, such a seizure threatened payments to other creditors of the sovereign obliger. Settlements typically are made at a discount in hard or local currency or in the form of new debt issuance. A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization. A prime example in the U.S. is K-Mart, where the real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
held by the company was the anticipated payout for investors who bought stock during their bankruptcy proceedings.
History
Sovereign debt collection was rare until the 1950s when sovereign immunity of government issuers was restricted. This trend developed due to the long history of sovereign defaultSovereign default
A sovereign default is the failure or refusal of the government of a sovereign state to pay back its debt in full. It may be accompanied by a formal declaration of a government not to pay or only partially pay its debts , or the de facto cessation of due payments...
ing on commercial creditors with impunity. Accordingly sovereign debt collection actions began in the 1950s. One example was the freezing of Brazil's gold reserves held by the Federal Reserve.
Investment in sovereign debt with the intent to recover was also restricted due to the laws of champerty and maintenance
Champerty and maintenance
Champerty and maintenance are doctrines in common law jurisdictions, that aim to preclude frivolous litigation. "Maintenance" is the intermeddling of a disinterested party to encourage a lawsuit...
and by the fact that most sovereign debt was syndicated. Under the doctrine of champerty, it was illegal in England and the United States to purchase a debt with the sole intent of litigating it. The distinction was made that if the debt was purchased to effect a recovery or facilitate investment, the doctrine was not a bar. Most jurisdictions have now eliminated the doctrine as archaic.
Similarly, sovereign debt owed to commercial creditors in the late 1980s was principally held by bank syndicates. This was the result of the petrodollar
Petrodollar
A petrodollar is a United States dollar earned by a country through the sale of petroleum. The term was coined by Ibrahim Oweiss, a professor of economics at Georgetown University, in 1973...
crisis of the 1970s when oil earnings were recycled into bank loans. The syndication of debt among banks made recovery impractical as a fund intending to litigate had to buy out the entire syndicate of holders or risk having the proceeds of litigation attached pursuant to sharing clauses in the loan agreements.
As the 1980s progressed, debt rescheduling efforts in Latin America created many new and easily traded instruments such as Brady bonds
Brady Bonds
Brady bonds are dollar-denominated bonds, issued mostly by Latin American countries in the 1980s, named after U.S. Treasury Secretary Nicholas Brady.-History:...
that brought new players into the market, including banks and hedge funds. The original creditors then wrote down their positions and sold the debt into the secondary market, a market consisting of banks and investment funds focused on buying at discounts to achieve above market returns on their investment.
In this process, much debt was repurchased and converted into local currency by the sovereign country issuers in official debt conversion programs designed to attract investment and in severely indebted countries through World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
funded buy-backs. The result is that the old syndicates were broken up and many unrestructured syndicate "tails" were available for purchase at discounts exceeding 80% of principal face value. That pricing encouraged funds to invest in recovery actions, which would not otherwise make financial sense due to their length and cost.
In 2011, the UK made permanent the Debt Relief (Developing Countries) Act 2010, which severely restricts the activities of vulture funds in mainland UK, although there are still havens for this activity, such as Jersey and The British Virgin Isles.
Vulture Fund FG Hemisphere run by financier Peter Grossman is trying to claim debt of $100m from the Democratic Republic of Congo, based on an initial loan of £3.3m he purchased from Bosnia's former Prime Minister Nedzad Brankovic
Nedžad Brankovic
Dr. Nedžad Branković is a Bosnian politician. He is the former premier of the Federation of Bosnia and Herzegovina after resigning in June of 2009. He holds a Ph.D...
(although the legality of this purchase has been brought into doubt by the Bosnian financial police). Grossman had previously tried to seize the DRC's Washington Embassy as down payment on the debt, but this was blocked by US authorities. His company tried to claim the debt once more in the US, and again in Hong Kong, before attempting to in the Jersey courts. The collection of this debt has been condemned by Unicef, saying that the money could be spent in saving 200,000 infant lives. When questioned whether he thought that his collection of the debt was fair, Grossman replied, "Yeah, I do, actually." Adding, "I am not doing anything wrong. I am collecting a legitimate debt."
External links
- Complicating the Morality Play on Vulture Funds (Corrected Story),Christopher Faille, Senior Financial Correspondent, Hedgeworld News,Monday, February 4, 2008,
- Distressed Debt Returns to the Spotlight FTfm,30 July 7,
- Cerebral Fund
- Africa Action Campaign to Stop Vulture Funds US
- Jubilee Debt Campaign action on vulture funds
- Investopedia: vulture fund
- Should Countries like Argentina be able to Declare Themselves Bankrupt?, by Anne Krueger
- Economics of Vulture Funds -Ft.com
- - August, 2003, Manmohan Singh, IMF Working Paper WP/03/161; "Recovery Rates from Distressed Debt - Empirical Evidence from Chapter 11 Filings, International Litigation and Recent Sovereign Debt Restructurings"
- Investigative Journalist Greg Palast Tracks Vulture Funds Preying on African Debt - video report by Democracy Now!Democracy Now!Democracy Now! and its staff have received several journalism awards, including the Gracie Award from American Women in Radio & Television; the George Polk Award for its 1998 radio documentary Drilling and Killing: Chevron and Nigeria's Oil Dictatorship, on the Chevron Corporation and the deaths of...