Secretary of the Commonwealth William F. Galvin on Monday launched an investigation of a New York-based junk-bond fund that froze its assets last week, a step that rattled investors and raised fears of a liquidity crunch in fixed-income markets.
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The review follows the firm’s announcement Thursday that it was closing its six-year-old, $789 million Third Avenue Focused Credit Fund and would likely bottle up investors’ money for months or longer as it tried to liquidate its assets. On Friday US high-yield bond exchange-traded funds fell to their lowest levels since 2009 in response to the news. Most hedge funds passed on the portfolio, which contained deeply distressed bonds and private equity investments that are hard to trade.
John Coffee, a professor at Columbia Law School, said the fund’s move may be seen as “high-handed, somewhat arbitrary”, but the alternative might have been a “total failure” of the fund.
The move roiled credit markets Friday and sparked widespread concern about other mutual funds with large holdings of corporate junk bonds. “This fund is definitely an outlier”, said Acheson. Of that amount, 34 percent is in the higher-quality segment with a rating of CCC+.
In a note released Tuesday morning, UBS analysts Matthew Mish and Stephen Caprio examined what could happen to investors as funds halt investor redemptions in order to stay liquid. Record-low interest rates have encouraged investors to take on more risk, including the debt of less creditworthy issuers, to get a higher return. After pouring almost $10 billion into high-yield bond funds and ETFs in October and the first week in November, they have since pulled out almost $7 billion, according to Thomson Reuters Lipper.
AllianceBernstein’s AB High Income Fund has the biggest holdings on a percentage basis this year among the largest junk bond funds.
The Wall Street Journal reported Monday that Third Avenue paid out all redemption requests through December 8, the night before it closed the fund; it then transferred all of its investments to a liquidating trust, which issued interests to be distributed to shareholders in the now-defunct fund. Run by Tom Lapointe, the fund bet on distressed situations, such as the bankruptcy-related claims of Lehman Brothers.
“I think that people are understandably frightened”, said Martin Fridson, chief investment officer for Lehmann Livian Frisson.
It’s important to understand this was not your run-of-the-mill mutual fund that invested in junk-rated bonds.
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Around $4 billion was withdrawn from high yield bond funds last week, the largest outflow in 10 weeks, while yields on sub-prime USA corporate debt securities jumped to pre-crisis levels of 17%.
