Last week, the world began to wake up to the fact that all of the “Chicken Littles” screaming that the sky is falling in high yield were right.
There was Third Avenue which announced it would gate investors in a $788 million mutual fund on the way to liquidating over the next several months (as though liquidity is set to return any day now in HY) and then in short order, the "venerable" Stone Lion Capital (founded by none other than Alan Jay Mintz and Gregory Augustine Hanley, both veterans of Bear Stearns distressed debt and HY trading desk) suspended redemptions after receiving “substantial requests.”
Yes, “substantial requests” or, in more colloquial terms, “rats from a sinking HY ship” and as we noted just moments after we confirmed the Third Avenue gate news, “investors in all other junk bond-focused hedge funds, dreading that they too will be gated, will rush to pull what funds they can and submit redemption requests, in the process potentially unleashing a liquidity - and liquidation - scramble within the hedge fund community, which will first impact bonds and then, if the liquidity demands continue, equities as well.”
It’s probably more appropriate to call that a foregone conclusion than “prescient.” That is, if one depositor loses access to his demand deposits and tells a friend about it, it won’t be long before the bank run is on. Same principle here.
Sure enough, just moments ago a third domino fell as Lucidus Capital Partners, a high-yield credit fund founded in 2009 by former employees of Bruce Kovner’s Caxton Associates, has liquidated its entire portfolio and plans to return its $900 million in AUM.
Unsurprisingly, the trouble at Lucidus started in October when a "significant investor" submitted a redemption notice. Following that request, Lucidus decided "to start winding down the portfolio and shedding staff," according to a person familiar with the fund’s operations who spoke to Bloomberg. "Shrinking trading volume in credit-default swaps and indexes in the wake of the financial crisis posed a challenge to Lucidus, whose founders sought to profit from volatile credit markets when they started the company in 2009, the person said."
"The fund has exited all investments. We would like to thank our investors and counterparties for their support over the years," Chief Executive Officer Christon Burrows and Chief Investment Officer Geoffrey Sherry said.
Here's a look at the management team:
The founders, Geoff Sherry and Darryl Green, were former heads of distressed debt trading at JP Morgan and Donaldson Lukfin, respectively.
Make no mistake, this will just add more fuel to the fire. As we've been warning for months, HY faces the dreaded "crowded theatre" scenario wherein the crowd has gotten larger and larger while the exit has become smaller and smaller.
Someone - or, more appropriately, several someones - yelled "fire" and now the rush to the exit is on. The question now is how quickly this spreads across the space and as we said last week, watch HYG and JNK closely to get a read on how quickly the panic is spreading to the more "mainstream" vehicles.
Unfortunately for those funds who plan on liquidating over the course of the coming weeks or months, liquidity is only going to dry up from here, and that means wide bid-asks and firesale prices, triggering harrowing declines that will only serve to spread more panic, leading to more redemption requests, and around we go. "After junk-bond prices posted their largest drop since 2011 on Friday, investors say they are bracing for another difficult week, likely featuring hectic trading and large splits between buy and sell orders," WSJ warned on Sunday, adding that "gaps as wide as 10% between the price bondholders are willing to accept and buyers are willing to pay are likely to be commonplace until at least the conclusion of the Federal Reserve’s two-day meeting Wednesday, hedge-fund and mutual-fund managers said."
One hedge-fund manager who spoke to The Jounral said he tried Friday morning to sell loans issued by Clear Channel Communications, now known as IHeartMedia (one of the Third Avenue fund’s largest holdings), at 71 cents on the dollar, the price Wall Street traders quoted him. "No buyers materialized until late afternoon when he received a single bid at 64 cents on the dollar, an offer he refused," WSJ says, rather ominously.
By the way, remember that the Street isn't going to be willing to inventory any of this paper, especially into a falling market. So ask yourself this: who's going to buy this stuff? And if buyers can be found, at what price?
We close with the following observation from Bloomberg's Richard Breslow:
One of the sad side-effects, is successful strategies, with liquid investments that are built for volatile markets and have no gates, become the piggy-bank for everyone that needs cash. Investors end up liquidating the good ones and are forced to keep the bad ones.