The shocking fate of Third Avenue's junk bond fund, which as we reported yesterday [9], announced it would gate investors and proceed to liquidate over the next several months as it sought to unwind its illiquid positions at a leisurely pace "without resorting to sales at prices that would unfairly disadvantage the remaining shareholders" is made just modestly less shocking when one considers that the $789 million fund (down from $2.4 billion earlier this year) was the worst performing YTD fund tracked by Morningstar, tumbling 27% YTD, but only after placing in the top 1%-percentile in 2013.
It is made less shocking when one considers that the fund, or rather its holdings, may have been the target of coordinated selling by other hedge funds who had smelled blood in the water, and decided to short all of Third Avenue's top holdings, holdings which were particularly illiquid and thus any attempts to sell in size would very likely be met by either gaping bid/ask spreads or, more likely, a bidless market.
This is the essence of the WSJ article [10]which explains that "part of the reason the Third Avenue fund ran into deep problems, traders said, is because it purchased investments that have become much harder to trade and have been steadily losing value as investors fled energy and other kinds of riskier debt in recent months. That squeezed the fund as redemption requests rose sharply this year."
Among the Focused Credit Fund’s largest holdings is a bond from media company iHeartCommunications Inc., formerly known as Clear Channel Communications Inc., according to Morningstar data. The bond traded recently at about 30 cents on the dollar, after trading at 80 cents at the start of the year, according to MarketAxess Holdings Inc.
In recent days, it has been harder to find traders willing to buy debt the fund holds, including energy company Magnum Hunter Resources Corp. and troubled Spanish gambling company Codere SA, traders said.
This also means that any hedge funds and traders who were short these names - oestinsibly through CDS just as we explained in How To Profit From The Coming High Yield Meltdown [11]- were making a killing. Hedge funds such as these:
As the Third Avenue fund’s holdings began to decline, rival traders at hedge funds shorted, or bet against, some of the mutual fund’s holdings, wagering that Third Avenue would experience investor withdrawals and be forced to sell some of its holdings, according to the company and one trader who made this move.
Recently, Third Avenue executives became wary of how rivals were targeting the fund’s holdings and worried it wouldn’t have cash to meet investor redemptions, sparking the decision to bar withdrawals, Mr. Barse said. “Our portfolio was well-known, it’s almost like we were targeted,” said Mr. Barse. He said the firm is doing everything possible to ensure the liquidation is done equitably for shareholders and notes that the firm’s executives and employees also are shareholders.
In short the shorts won, and Third Avenue's fixed income, aka junk bond, fund is no more. It won't be the last.
What happens next? Well, as the WSJ explains "now, investors are focused on whether other funds may run into similar investor withdrawals and problems as the year-end approaches. Many investors move to exit losing funds and investments late in the year to generate losses to reduce capital gains taxes, traders said."
In other words, now that the first casualty in the junk bond space has spilled its blood in the water, the hungry sharks are circling. And perhaps the best place to look for the chum is where Third Avenue itself was discovered: dead last in the morningstar list of worst (and best) performing High Yield funds of 2015 [12], as shown below.
[13]
If we were Catalyst, or Nuveen or Franklin, or any of the other names listed above, we would be taking a long, hard look at our junk bond holdings right about now...
