Third Avenue Management just couldn’t take the pain anymore.
Instead of continuing to sell distressed-debt holdings at incredibly low prices, the asset manager decided to make a drastic move that will inevitably kill some of its future business. It chose to prevent investors from leaving its Third Avenue Focused Credit Fund, a $788 million mutual fund that it has decided to liquidate.
That means that these investors who want their money back are becoming “beneficiaries of the liquidating trust” without a sense of when they’ll actually get anything back, according to a notice to its shareholders dated Wednesday. “Third Avenue is extremely disappointed that we must take this action,” it said.
That’s probably an understatement. The Third Avenue fund was aiming to provide huge returns to investors by buying incredibly risky debt when it started in 2009. But when this debt turned out to have actual risks, the fund couldn’t sufficiently exit its positions to meet investor withdrawals.
On one hand, it’s understandable -- and even responsible -- for Third Avenue to throw up some investor gates. The fund owns a lot of bonds that have have been decimated this year. Any further selling will leave current investors with huge losses, some of which may be avoided with a little more time.
A substantial portion of the fund, which had $3.5 billion in assets not long ago, consists of the lowest-rated junk bonds, which have on average plunged almost 13 percent in 2015, their biggest negative return since 2008. They are underperforming higher-quality bonds by the most since 2009. The credit fund’s biggest publicly listed holding is debt of iHeartCommunications that has fallen 54 percent just since the end of June. It also has a large position in bonds of Claire’s Stores that have dropped 55 percent, also just since June, to 16.5 cents on the dollar.
Third Avenue may have been caught in a self-fulfilling spiral. As investors demanded their money back because of falling prices, the firm was forced to liquidate its holdings, pushing the prices lower on the lowest-rated notes and spurring even more redemption requests.
Contributing to the big price declines were sellers simply cutting their losses and shedding their positions at all costs, just to move on with their lives. Potential buyers smell blood in the water and are happy to stand by and wait for prices to fall even more.
This is a prime example of one type of bond-market liquidity problem that many have been talking about. Some U.S. regulators have tried to debunk the idea that a crisis is brewing in credit markets as a result of a lack of liquidity. Those policy makers may very well be right in that a fund’s liquidation won’t lead to a systemic meltdown and will simply be another casualty of a difficult year for investors.
But the fact that Third Avenue took the significant, relatively uncommon move of locking in its remaining investors shows the level of desperation in the lowest-rated credit right now. More casualties can be expected, and they will continue to weigh down prices of highly speculative assets. That will have a broader effect, especially on skittish investors who want to exit stage left.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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