istressed Securities portfolios invest in both debt and equity of companies that are in or near bankruptcy. Distressed debt and equity securities are fundamentally different from non-distressed securities. Most investors are unprepared for the legal difficulties and negotiations with creditors and other claimants that are common when dealing with distressed companies. These risks require unique skills and investors generally prefer to transfer those risks to specialists in the distressed market when a company is in danger of default. Further, many investors are prevented by charter from holding securities that are in default or at risk of default. Because of the relative illiquidity of distressed debt and equity, short sales are difficult, and most funds are primarily long.

There are many reasons offered for the underpricing of distressed securities. In addition to financial risks, many investors prefer to avoid securities in distress because of the potential career risk associated with holding securities that lose all their value and the headline risk associated with actively pressing claims against a company that is operating at or near bankruptcy.