As signs of stress mount in credit markets, a $788 million mutual fund took the unusual step of blocking clients from pulling their money so its holdings can be liquidated in an orderly fashion.
Martin Whitman’s Third Avenue Management said it put some of the assets in the Third Avenue Focused Credit Fund in a liquidating trust that will seek to sell them over time, the New York-based firm said on its website dated Dec. 9.
Investors will receive interests in the trust on or about Dec. 16. Any cash that isn’t required for the fund’s expenses and its liquidation will be returned that day.
The unorthodox step comes after regulators raised concerns that some mutual funds are investing in assets that could be hard to sell in a market rout. David Barse, Third Avenue’s chief executive officer, said blocking redemptions was necessary to avoid fire sales. The fund, which had $3.5 billion in assets as recently as July of last year, suffered almost $1 billion in redemptions this year through November.
“We believe that, with time, FCF would have been able to realize investment returns in the normal course,” David Barse, the firm’s chief executive officer said in the statement.
“Investor requests for redemption, however, in addition to the general reduction of liquidity in the fixed income markets, have made it impracticable” for the fund “to create sufficient cash to pay anticipated redemptions without resorting to sales at prices that would unfairly disadvantage the remaining shareholders,” he wrote.
Daniel Gagnier, a spokesman for Third Avenue, declined to provide details about the level of redemptions .But according to Morningstar, clients pulled an estimated $979 million this year through November. Combined with a 27% loss so far this year, the fund has $788 million as of Dec. 8.
U.S. corporate debt has fallen this year, weighed down by 3.5% losses in junk bonds that are poised to deliver the first annual loss since 2008, according to Bank of America Merrill Lynch Indexes.
Credit quality in speculative-grade debt is falling. For every junk-bond issuer that had its rating boosted this year, two have been downgraded, a ratio not seen since 2009, according to data compiled by Bloomberg. And companies are increasingly defaulting on their debt. Swift Energy's failure to make an $8.9 million interest payment last week raised the global tally of defaults to 102 issuers, a figure last exceeded in 2009, according to Standard & Poor’s.
Other funds also have had a tough time recently. Last week, Meridee Moore told clients she was returning money in her $1 billion hedge-fund firm Watershed Asset Management, citing the difficulty finding good investments in distressed companies.
“The last eighteen months have seen grinding declines in stressed and distressed credit and special situations equities,” Moore wrote in a letter dated Nov. 30.
Jeffrey Gundlach, founder of DoubleLine Capital, highlighted the same difficult conditions in a conference call with investors Tuesday. "We’re looking at real carnage in the junk bond market,” Gundlach said.
In September, the U.S. Securities and Exchange Commission proposed new rules that would require funds to maintain a minimum cushion of cash or cash-like investments that can be sold within three days. Another proposal would allow funds to offer less favorable share pricing to investors who pull their money during periods of elevated withdrawals.
The SEC has also ramped up its exams of bond mutual funds, grilling managers about how easily they think they could sell holdings if trading dried up and probing whether disclosures appropriately describe how a jump in interest rates might affect debt investments.
“It is highly unusual to see a liquidation of a fund of this scale,” Jeff Tjornehoj, a Lipper analyst said in a telephone interview. “Normally it happens to funds with $10 or $20 million.”
The Investment Company Act of 1940 requires mutual funds to stand ready to redeem their shares at net asset value on a daily basis. Suspending such redemptions would normally require an explicit authorization from the SEC, securities attorneys said.
Instead of paying out cash, Third Avenue is meeting the law’s requirement by redeeming the fund’s shares for interests in a trust that will hold the focused credit fund’s assets, primarily high yield bonds and corporate bank loans. This technique could eliminate the need to get an SEC order authorizing a suspension of redemptions, said Jay Baris, the chair of Morrison & Foerster’s investment management practice.
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