Third Avenue Focused Credit Fund
High-yield bonds got one mutual fund into trouble. On December 10, 2015, Third Avenue Management announced that redemptions were barred from the Third Avenue Focused Credit Fund (TFCVX) (TFCIX).
Apart from Advanced Micro Devices (AMD), there weren’t many large companies that the fund invested in. Most of its assets were invested in small companies either in the middle or deep in the junk territory. Holdings from the energy sector, whose performance hurt stock across Schlumberger (SLB), Marathon Petroleum (MPC), Valero Energy (VLO) accounted for 6.9% of the fund’s assets.
David Barse, Chief of Third Avenue Management, wrote to investors that “We believe that, with time, the fund would have been able to realise investment returns in the normal course.” However, he added that the fund house wouldn’t be able to let investors redeem their investments any longer.
Why did this happen?
The collapse of the Third Avenue Focused Credit Fund was the result of three things:
- Illiquid assets
- Investor redemptions
- Tightening liquidity conditions
As shown in the above graph, the TFCVX—Investor Class of the Third Avenue Focused Credit Fund—had a terrible showing. As of December 10, 2015, adjusted for dividends, the fund fell by ~30% YTD (year-to-date).
A lot of the poor performance had to do with illiquid assets and investors redeeming their units.
Once you put in a request for redemption, fund management needs to sell part of the holdings to give you back your due. Now, imagine a scenario where lots of investors are putting in redemption requests. Fund management will need to offload a larger quantum of securities in order to honor those requests for redemption.
But what if a sizable amount of securities are illiquid—there are no takers for it in financial markets? It means that either you can’t sell securities or sell them at rock bottom prices leading to tremendous losses.
Combined with falling liquidity, investor redemptions made the fund dig deep into its portfolio to sell junk bonds. However, it couldn’t go deeper without seriously impacting the remaining shareholders. As a result, it decided to block redemptions.
The remaining shareholders will get a stake in a Liquidation Trust that will sell holdings in an orderly manner. The fund house announced an initial cash distribution of $0.59 per share to all shareholders on December 16, 2015.
Since we’re talking about liquidity, let’s look at the flows into high-yield bond funds (JHYAX) in the next part.