Mutual fund's implosion highlights bond mart risks
The shocking implosion this week of a junk-bond fund at New York's Third Avenue Management -- founded by legendary investor Martin Whitman -- highlights the perils of piling up on risky debt.
Third Avenue Management on Thursday froze investor withdrawals from the junk-bond fund, which has seen nearly $1 billion in redemptions this year and had about $780 million in assets remaining on Friday. The firm said it was no longer feasible for investors to pull their money without the fund's managers having to dump junk-bond holdings at fire-sale prices, which "would unfairly disadvantage the remaining shareholders," it said.
Third Avenue declined to elaborate further, spokesman Daniel Gagnier told CBS MoneyWatch in an email on Friday.
The U.S. Securities and Exchange Commission said in an emailed statement: "We are in communication with representatives of the fund and are currently monitoring the situation."
The redemption freeze underscores some of the risks behind junk bonds and other so-called high-yield credit investments. Investors have been dialing back their exposure to the riskiest asset classes amid an ongoing rout in commodity prices, worries about liquidity in times of market stress, and long term predictions of rising interest rates following a widely expected Federal Reserve rate hike next week.
"This is not out of the blue -- it's been an issue for awhile now," said Peter Boockvar, chief market analyst at the Lindsey Group. "Equity people have missed the slow deterioration of high yield [bonds]. Sometimes you need to be reminded, and Third Avenue was a wake-up call to anyone who wasn't paying attention."
Boockvar believes the Fed's years of easy monetary policy ultimately fostered the scenario, saying: "Zero interest rates created an enormous demand for yield, and people put aside the potential risk to just focus on reward, and that always ends badly."
Others pegged the continuous slide in the price of crude oil as the major underlying factor for the fund's troubles. Third Avenue was the biggest holder of one set of bonds issued by bankrupt power producer Energy Future Holdings Corp., according to Bloomberg News. At least one-fifth of Third Avenue's Focused Credit Fund last week was composed of illiquid assets, meaning they trade so infrequently that they don't have a market price, according to Reuters.
"The gates were put up yesterday, and it does speak to the [lack of] liquidity of the high-yield market in general, not just energy," said Jim Russell, portfolio manager, Bahl & Gaynor. Still, he added, "the price of oil figures in pretty heavily here."
The week also saw a bid to conserve capital by Kinder Morgan (KMI), North America's largest energy infrastructure company, which on Wednesday said it would slash its quarterly dividend to 12.5 cents a share from 51 cents a share. The company is a "bellwether for the general MLP [master limited partnership] market," said Russell.
"Kinder is not a junk-bond company," Russell continued, "but what it does is show you just how rapidly perceptions can change as commodity markets continue to decline in price, especially amongs highly leveraged companies that have exposure to commodity prices and need continued access to capital markets."
Another eyebrow-raising event this week: Freeport-McMoRan (FCX), the world's largest publicly traded copper producer, said it would suspend its common stock dividend to save about $240 million a year.
Both moves came a day after mining-giant Anglo American said that it would cut 85,000 jobs and suspend its dividend payments for the rest of this year as well as in 2016.
The fall in the price of oil and other commodities is hitting highly leveraged companies that require access to capital markets. "What the markets did was price their debt at not affordable," Russell said. "The capital markets are acting as the market's policeman at this point in time. It's doing it very rapidly, by the way."