Most people who invest in mutual funds consider them liquid with the money always being a withdrawal away. Well, that is not the case with one junk bond fund. Third Avenue’s Focused Credit Fund had large losses and investors were withdrawing their money at such a rate that the company decided to liquidate the fund. They also decided to bock investors request to withdraw money. Investors will eventually get their money. It just won’t nearly be what was originally invested.
It is the largest investment implosion since the financial crisis. The fund has lost over 50% since last year.
The company’s reason for blocking investor withdrawals is quite simple. The fund company has to sell assets to raise money to pay back investors. If they are forced to rush to sell assets, then buyers will only give them pennies on the dollar. They are going to attempt to liquidate in an orderly fashion rather in a panic mode.
Regardless of the reason, shareholders of this once 3 billion fund (now only 789 million) are going to lose big time. These are the riskiest of credit investments that this fund holds and no buyer is going to want this junk unless it is pennies on the dollar.
Is this the start of something and not a problem that is isolated to the junk bond market? I say that it is very possible. Now that could be taken as over sensationalizing an isolated incident. However, you have to consider the dynamics.
The fund took heavy losses because of risky debt. Then you have investors who want out. The fund manager is forced to sell the risky debt. There are no buyers at current prices. However, there are buyers at much lower prices. Debt is destroyed through loss.
You could apply the same formula to the other parts of the bond markets. Remember rising interest rates cause falling bond prices. If investors start demanding their money back from bond funds, do you think that they fund managers are going to be able to sell their bonds at attractive prices? This is what regulators fear – illiquidity. This occurs when you can’t sell an asset for the going value and easily receive the money. It can happen in all parts of the bond market just as easily as the junk bond market.
The potential for a domino effect is enormous. I think that we will see a time where people don’t want to buy bonds. After all, it represents debt and debt can go into default during times of financial crisis.
This reminds me of a New Century, a subprime mortgage originator, who in 2007 prior to the financial crisis imploded. Everyone called that an isolated incident. A few years later we learned it was the first of many subprime mortgage originators and financial companies that were to go belly up.
It is all about the debt. Today, the amount of troubled debt dwarfs the debt of the financial crisis. The key is to watch the bond market. I think Third Avenue is only a small tell of what is to come.