a decision to liquidate

Last week the Third Avenue Focused Credit Fund (TFC), a junk bond fund managed by well-known value investor Third Avenue Management, decided to cease normal operations and liquidate itself.

The fund had lost about two-thirds of the assets it had at its high point to a combination of market losses and investor redemptions.  TFC apparently had reached the point where it determined it could only sell further holdings at big price concessions.

Rather than do so, the directors of the fund opted to stop honoring redemption requests, distribute all its cash on hand to shareholders and put the remaining fund assets into a liquidation trust.  Third Avenue is in the process of issuing shares in this trust to TFC shareholders, who will receive the proceeds of liquidation sales as and when they happen.

How did this happen?

According to the New York Times, the lead portfolio manager of TFC was telling investors that everything was fine two months ago.

I’ve looked at the SEC filings for TFC since mid-2014.  Three things jump out at me (remember, though, I’m a stock guy, not a junk bond person):

–there’s no undue concentration in any industry or sector area (I’d suspected there might be)

–the percentage of assets classified as “level 3,” meaning basically that they’re being valued by a theoretical model rather than a daily market price, went from negligible in mid-2014 to about 20% of assets in September 2015.  I don’t know whether this came about through a change in portfolio strategy (which would strike me as odd) or whether it’s the result of liquidity drying up in the bonds TFC held.

–net assets were about $2 billion on September 30th.  According to the NYT, they had shrunk to $790 million ten weeks later.  That implies an avalanche of redemptions.

What caused the massive outflow?

Who knows.  My only observation is that the majority of shares were “institutional,” which typically means each holder had at least $500,000 worth of shares.  Maybe a small number of them represented a large chunk of the fund’s assets and they all decided to allocate away from TFC during their year-end planning.

I’ve seen stuff like this happen before

In most of the instances I’ve observed, however, the fund is part of a large asset management group–a brokerage firm or a bank–that steps in and buys the illiquid assets at the fund’s carrying value, thus providing money to meet redemptions.  Third Avenue is apparently not big enough to do so.

lessons?

Not many.

Past junk bond crises have shown that this asset class is much less liquid than one might think.  Also, if things turn ugly it’s probably better to own shares in a fund with a deep-pocketed parent.