Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

There are times when mutual funds look a bit like banks.

So it goes with Third Avenue Management, the asset manager that’s shrunk from $26 billion in 2006 to about $5 billion earlier this year. The firm is reportedly trying to wash its hands of its Focused Credit mutual fund, which blew up in December after preventing investors who were trying to flee from leaving. While the firm has been selling some of the fund’s holdings to repay remaining investors, it’s now looking for a firm to buy the remaining $600 million of assets in one fell swoop, according to a Wall Street Journal article on Thursday.

Years of Loss
The Third Avenue Focused Credit Fund has performed poorly for years
Source: Bloomberg

This sounds a lot like the process that many big banks went through after the 2008 financial crisis. Firms from Bank of America to UBS had billions of dollars of distressed assets that they cordoned off into bad banks with separate staffs responsible for winding them down. Some banks like UBS sold entire portfolios at once. Others opportunistically shed securities a little at a time. Many firms did a combination of both.

Enter Third Avenue, which has been under close scrutiny from both shareholders and the U.S. Securities and Exchange Commission since December, when it opted to prevent investors from fleeing its distressed-debt mutual fund. At the time, the goal was to avoid selling the underlying securities at a steep discount into a souring market.

It's possible that a buyer will emerge with an offer that's acceptable to both shareholders and the SEC. After all, U.S. distressed corporate bonds have returned 31 percent in 2016 and 4.1 so far this month, according to Bank of America Merrill Lynch index data.

Pain Valley
Risky-debt prices have rebounded since Third Avenue blocked investors from leaving a credit fund
Source: BofA Merrill Lynch US Distressed High Yield Index

If that's the case, the Third Avenue fund's remaining shareholders would essentially be betting that the rally in the riskiest credit is nearing an end, while the bidder would have to believe more gains are coming. Or else the investors won't care about the details as much as getting as much of their money back as quickly as possible.

Regardless of the outcome, one thing seems clear: Even a tidy resolution to the fund's demise won't remove a growing amount of skepticism toward mutual funds that invest in assets that trade infrequently. The parallels that can be drawn between Third Avenue and big banks after the 2008 financial crisis only solidify that apprehension.

Regulators have spent years scrutinizing the plausibility of a run on debt mutual funds. The idea is that investors all want to leave at once when it's incredibly difficult to sell the underlying assets. The recent frenzy over U.K. real-estate funds only solidifies this sense of concern. 

The SEC conducted extensive interviews with high-yield fund managers after the Third Avenue credit fund seized up. While it found that Third Avenue's fund was not representative of the broader industry, the regulator is still scouring the mutual-fund landscape for any similarly risky funds and considering new guidelines to test mutual funds' liquidity. 

Regulators are on alert and investors are increasingly wary. While Third Avenue is looking to move forward, its missteps have put a permanent blemish on the industry that won't be removed in the bad-bank rinse cycle. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net