Distressed Debt Could Be Bad Fit for Some Funds, Regulator Says

  • SEC's Grim: Some assets might be too illiquid to hold
  • He emphasizes commission's support for enhanced liquidity

The top U.S. regulator of mutual funds said the failure of a high-yield mutual fund in December suggests that some assets may be too illiquid to be held in large amounts in traditional funds.

“I believe certain investment strategies -- such as those focused heavily on distressed debt -- may be more suitable as closed-end or private funds, rather than as funds that are subject to daily redeemability,” David Grim said Monday in a speech to a meeting of the Investment Company Institute, the mutual fund industry’s main trade group. Grim, director of the division of investment management at the U.S. Securities and Exchange Commission, didn’t provide details on the type of limits he might consider.

Third Avenue Management halted redemptions and shuttered its $788.5 million Focused Credit Fund in December after losses and withdrawals left the firm unable to meet obligations without selling assets at fire-sale prices. The move triggered a broad selloff in high-yield bonds as fears grew that the damage might spread to other funds.

Grim, in his remarks, said the incident reinforced his view that it was critical for mutual funds to maintain adequate liquidity in their portfolios. Last September, the SEC introduced a proposal to ensure easy entry and exit for investors.

Under the plan, funds would have to maintain a minimum cushion of cash or cash-like instruments that can be sold within three days. Funds also could charge investors who pull their money on days of elevated withdrawals.

Grim said the commission had received almost 80 comment letters on the liquidity proposal and that the issue was still under review.

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