High Yield: Hang In or Bail Out?

On the liquidation date, the fund company makes a final pro-rata cash distribution to any remaining shareholders.

Of course, there’s a big difference between a bond fund underperforming and actually closing up shop and barring investors from taking money out. What’s more, around 20% of the assets of the Third Avenue fund were in bonds that didn’t actively trade. There are two issues here. And people who still have that fund in their retirement account are getting cleaned out. Management is trying to not have a fire sale.

Quantitative easing – which has added about $3.5 trillion to the Fed’s balance sheet, and will expand the ECB’s balance sheet by more than $1 trillion – has destroyed the valuation mechanisms for government bonds.

Assets in the Third Avenue fund had already fallen from $3.5bn last July to $788m, with investors removing $979m in assets this year to November, according to Bloomberg.

Because we’ve just seen the biggest mutual fund failure in the USA since 2008…

Furthermore, the downward slide in energy prices has been greater than most investors anticipated, putting pressure on markets from USA manufacturers to emerging-market commodity exporters, according to Krishna Memani, chief investment officer for OppenheimerFunds. The firm then chose to stop accepting redemptions and to transfer the fund’s assets to a liquidating trust. AMG could not immediately be reached for comment.

One of the concerns is that the reason high-yield bond prices are dropping so fast is that funds are having trouble selling them. He expects we’ll have one within a few years.

The sell-off is in part a reaction to the Third Avenue closure and its decision to suspend redemptions.

It works like this: When an “open-end” bond fund starts losing money, investors begin to sell it. Fund managers first use all available cash to pay investors.

Two negative developments, in particular, caused the dramatic sell-off. Interest rates on existing bonds are adjusted by lowering bond values, including junk bonds. Manager David Baldt was later charged with insider trading. And Morgan Stanley in its Monday research note said that the high-yield market has gone through other periods in which withdrawals were high, and done fine.

The question is whether the meltdown in the high-yield market foreshadows nastier events to come in US equity markets. Investors were left with sizable losses but were ultimately able to redeem their investments. Third Avenue will face redemptions and there could be a domino effect.

Third Avenue Focused Credit stood out for its large, concentrated allocation to distressed and other low-quality fare. American Eagle Energy is in Chapter 11 bankruptcy and its debt was trading for less than 5 cents on the dollar Monday.

Now, most investors are aware of the fact that fixed income ETFs are least affected in volatile markets because they have shorter maturities.

Local fund managers have also been paying attention.

Sparer Law Group is investigating whether the Fund’s registration statements and prospectus misled investors about its liquidity and risk. The major sector with the next largest drop was industrial, which was down less than 6%. Positions like these could be hard to unwind in a stressed credit market.

“However, that’s not so much the risk; the risk is that what happens in high yield can sometimes be a canary in the coalmine”. This close to zero, the argument goes, it might even be a sensible to push rates higher, thus giving more ammunition for later if more stimulus is required. That was after dropping 2% on Friday, the biggest daily fall since 2011.