The Next Leg Of The Junk Bond Crisis: Third Avenue "Focused Credit Fund" Liquidates, Gates Redemptions

 

Moments ago, we learned courtesy of the head of Mutual Fund Research at Morningstar, Russ Kinnel, that the next leg of the junk bond crisis has officially arrived, after Third Avenue announced it has blocked investor redemptions from its high yield-heavy Focused Credit Fund, which according to the company has entered a "Plan of Liquidation" effective December 9.

The redemption block takes place after the fund lost some 27% in 2015, with assets plunging by a whopping 66%.

Not surprisingly, the fund is in the worst percentile with 100% of funds outperforming YTD, however we can only assume that it had accumulated its $789 million in AUM (down from $2.4 billion earlier this year) as a result of being in the top 1% in 2013.

This is what happened, according to the fund manager:

We believe that, with time, FCF would have been able to realize investment returns in the normal course. Investor requests for redemption, however, in addition to the general reduction of liquidity in the fixed income markets, have made it impracticable for FCF going forward to create sufficient cash to pay anticipated redemptions without resorting to sales at prices that would unfairly disadvantage the remaining shareholders.

As a result, all shareholders will be equally disadvantaged.

How long will investors have to wait for the "Liquidating Trust" to become, well, liquid? Quite a while:

In line with its investment approach, FCF has some investments in companies that have undergone restructurings in the last eighteen months, and while we believe that these investments are likely to generate positive returns for shareholders over time, if FCF were forced to sell those investments immediately, it would only realize a portion of those investments’ fair value given current market conditions. We believe that doing so would be contrary to the interests of all of our shareholders, which is why we have taken steps to protect shareholder value by returning cash and implementing the Liquidating Trust to seek maximum value for these investments.

At least it won't cost you anything:

Third Avenue will manage the Liquidating Trust in order to obtain the best overall outcome for the beneficiaries. Third Avenue will not charge any fee for those services.

Finally:

Third Avenue is extremely disappointed that we must take this action.

So is everyone else:

Here is the official statement:

A history of the fund from Bloomberg:

Then again, as Kinnel snydely notes...

What this means is that now that the dreaded gates are back, 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.

For those curious, here are the top holdings of the fund:

Keep a very close eye on HYG and JNK now that gates are officially back after a 7 year hiatus.

Closing Market Summary: Stocks Snap Three-Day Skid

The stock market ended Thursday on a higher note, putting an end to its three-day skid. The S&P 500 climbed 0.2%, but could not hold posture above its 50-day moving average (2,054). Meanwhile, the Dow (+0.5%) and Nasdaq (+0.4%) settled ahead of the benchmark index.

The Thursday advance did not occur without some theatrics as the S&P 500 marked a morning high during the first 90 minutes of the day and followed that with a return to its flat line. The benchmark index charged to a fresh high in the early afternoon, but backtracked from that level to end in the lower third of today's range.

Equity indices spent the first hour of action near their flat lines, but the energy sector (+0.6%) displayed relative strength from the start, which underpinned today's advance. The sector narrowed this week's loss to 3.2%, ending in the lead even though crude oil fell 1.0% to $36.80/bbl. The energy component continued sliding in electronic trade, which forced some backtracking in the sector. It is worth noting that the prolonged weakness in oil prices prompted Chevron (CVX 89.30, +1.70) and ConocoPhillips (COP 49.22, +0.75) to cut their respective capital expenditure budgets for 2016 by 24.0% and 25.0%, respectively.

The energy sector was the only pocket of strength in the early going, but the growth-sensitive group held its ground even as the S&P 500 retreated from its opening high during the early afternoon. The benchmark index approached its flat line around 12:15 ET, but did not dip below its opening levels thanks to late morning strength in high-beta groups. Specifically, biotechnology, chipmakers, and transport stocks got off to a sluggish start, but all three areas settled ahead of the broader market, which contributed to the afternoon push to a fresh session high.

The iShares Nasdaq Biotechnology ETF (IBB 329.41, +4.21) spiked 1.3% while the broader health care sector gained 0.8%, narrowing this week's loss to 0.6%. Elsewhere, the Dow Jones Transportation Average climbed 0.6% with airlines rebounding from recent weakness, helping the industrial sector (+0.5%) end among the leaders.

For its part, the PHLX Semiconductor Index gained 0.6% with all but eight components ending in the green; however, that strength was overshadowed by a mixed showing from large cap members of the technology sector (+0.2%).

On the downside, materials (-0.8%) and utilities (-1.7%) spent the day in negative territory with the materials space pulling back after yesterday's 3.1% surge.

Treasuries spent the day inside narrow ranges, slipping to lows just ahead of the close. The 10-yr note settled on its low with the benchmark yield rising two basis points to 2.23%.

Today's participation was relatively light with fewer than 850 million shares changing hands at the NYSE floor.

Economic data included Initial Claims, Import/Export Prices, and Treasury Budget:

• Initial claims for the week ending December 5 increased by 13,000 to 282,000 (consensus 269,000) while continuing claims for the week ending November 28 jumped by 82,000 to 2.243 million (consensus 2.167 million)
  • There were no special factors influencing initial claims, which have remained bounded between 250,000 and 300,000 since July 2014
• Export prices, excluding agriculture, decreased 0.6% in November after decreasing 0.3% in the prior reading
  • Excluding oil, import prices decreased 0.3%, which followed last month's decrease of 0.3%
• The November Treasury Budget showed a deficit of $64.60 billion
  • The Treasury data are not seasonally adjusted, so the November deficit cannot be compared to the October deficit of $136.50 billion
  • Total receipts in November were $205.00 billion while total outlays were $269.50 billion
  • Receipts were $13.50 billion more than November 2014 receipts while total outlays were $21.30 billion more than November 2014

Tomorrow, November CPI (consensus +0.1%) and November Retail Sales (consensus +0.3%) will be reported at 8:30 ET while October Business Inventories (expected +0.1%) and the preliminary reading of the Michigan Sentiment Index for December (consensus 91.6) will both be released at 10:00 ET.

• Nasdaq Composite +6.5% YTD
• S&P 500 -0.3% YTD
• Dow Jones Industrial Average -1.4% YTD
• Russell 2000 -4.3% YTD