What Led to the Demise of Third Avenue’s Focused Credit?

What Led to the Demise of Third Avenue’s Focused Credit?

The demise of Third Avenue’s Focused Credit Fund shows that not all strategies, especially those with concentrated bets in low quality bonds, belong in an open-end vehicle, Morningstar says.

In a letter to shareholders, Third Avenue announced plans last week to shutter its Focused Credit Fund, which invests in high yield bonds and had about $789 million in assets. The fund had suffered lately from poor performance, having lost 27 percent for the year through Dec. 9, and net outflows of $1.3 billion through November, according to Morningstar.

The firm said it will pay out a distribution to shareholders on Dec. 16, and the rest will be placed into a liquidating trust. Third Avenue is no longer taking redemptions, and the liquidation process may take up to a year.

“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,” the firm said in a statement.

In a recent post, Morningstar writes that it’s highly unusual for a fund to halt redemptions like this and have a long liquidation period. There has been some precedence with municipal bond funds, which tend to be more illiquid. Typically, a fund company gives shareholders advance notice and allows investors to make redemptions up until the liquidation date.

Jeffrey Ptak, head of global manager research at Morningstar, and analyst Sarah Bush write that the decisions leading to the fund’s performance were “a profound management failure.” But they believe the way the fund company handled the liquidation was prudent.

“It will help shareholders salvage whatever value the bonds can fetch in a more stable high-yield climate at a later date,” Ptak and Bush write.

It's not likely to see a similar failure to other high-yield or bank-loan funds, as most hold more diversified issuers and are more concentrated in higher-quality, more-liquid bonds than the Third Avenue fund, they state.

The fund’s downfall was due in part to its large concentrations in low-quality and distressed debt, and this is something investors ought to look out for.

“Positions like these could be difficult to unwind in a stressed credit market,” Ptak and Bush write. “Probably the biggest lesson is that certain strategies, like concentrated distressed debt investing, are not suited to an open-end format that demands daily liquidity. That mismatch is what ultimately cost the fund and its shareholders.”

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