Dec 11/15 – And so it begins…

2015-12-11 12pm EDT  |  #BKLN #bonds #credit #HYG #JNK #Third Avenue Management

And so it begins…

Yesterday Third Avenue Management announced they were halting redemptions in their “Focused Credit Fund” due to illiquidity of the high yielding fixed income securities in their portfolio.

From the WSJ:

A firm founded by legendary vulture investor Martin Whitman is barring investor withdrawals while it liquidates its high-yield bond fund, an unusual move that highlights the severity of the monthslong junk-bond plunge that has swept Wall Street.

The decision by Third Avenue Management LLC means investors in the $789 million Third Avenue Focused Credit Fund may not receive all their money back for months, if not more.

Third Avenue said poor bond-market trading conditions made it almost impossible to raise sufficient cash to meet redemption demands from investors without resorting to fire sales of assets.

Securities attorneys said Third Avenue’s decision to wind down the mutual fund without giving investors all their cash back could have significant repercussions for both the company and the mutual-fund industry, which for decades has thrived by promising to allow investors to take a long-term view of the markets while retaining the right to cash out shares at any time.

While hedge-funds have occasionally prevented investors from taking out their money, such a move is uncommon for a mutual fund.

The move is also a sign of how much the market for corporate debt is deteriorating following a long boom.

During the past year and a half the performance of the “Focused Credit Fund” has been abysmal, and it only seems to be getting worse:

For Third Avenue Management to take the unprecedented step of gating the fund means conditions are much worse than I previously believed. This isn’t some fly-by-night hedge fund operation that has suddenly blown up. This is a respected money manager whose reputation will be thoroughly sullied by this move. Things must be dire.

It’s not like Third Avenue is alone in their underperformance. It has been an extremely difficult year for many money managers and especially punishing for high yield managers.

After the 2008 credit crisis, too many investors chased fixed income. At first they bought the relatively safe stuff, but as those yields were slowly squeezed to zero, investors ventured farther and farther out the risk curve. Products such as the Powershares Senior Loan ETF took off in popularity:

And it wasn’t just bank loans that enjoyed massive investor inflows. High yield funds seemed to offer the benefits of stock like returns with a coupon attached.

However like every good story on Wall Street, it was taken too far. Much too far.

Eventually the rally in credit securities reached a point where investors were not discerning between good and poor risks, they were simply buying because it was going up.

Now as the Fed withdraws the liquidity that was previously buoying all credit, investors are suddenly faced with the stark realization that high yield bonds can also decline in price…

The news about Third Avenue gating redemptions has brought the direness of the situation to the forefront.

This is terrible price action, and given all the bad news, I don’t see where the bounce will come from.

The Fed has been clueless about the effect their policy guidance has had on financial conditions, and this morning, full on panic is setting in.

I remember the last time a seemingly nondescript hedge fund halted redemptions. At the time, Bear Stearns insisted it was a temporary condition. Even the Fed believed the problems with mortgage securities were isolated. Of course we all know that the halting of redemptions by the Bear Stearns hedge fund was simply the first step in what proved to be a painful unwind that brought the global financial system to its knees. It is hugely ironic that Michael Lewis’ movie about this period is just hitting the theatres.

But don’t worry – Wall Street and the Federal Reserve learned their lesson during the last crisis. No way they found a way to make new mistakes. I am sure the Third Avenue credit fund problem is an isolated problem. Yeah, right…

Thanks for reading,

Have a great weekend,

Kevin Muir

the MacroTourist