a footnote to yesterday’s post

Yesterday I wrote about the Third Avenue Focused Credit fund, which shut itself down amid a tsunami of redemptions.  (The SEC has since blessed its liquidation plan, by the way.)

Several thoughts:

–Typically, institutional clients abhor their managers keeping cash reserves.  Their idea is that they do the asset allocation, which they consider the brainy part of the business, and leave the details to the managers they hire.  They don’t want managers upsetting their asset allocation plans by holding more than a tiny amount of cash.  On the other hand, they want the ability to withdraw their funds instantly that the mutual fund/ETF form gives them.  Given that the majority of the shares of the Focused Credit fund were “institutional,” this may have been part of the fund’s problem.  In hindsight, the institutions should have had separate accounts to hold their money in.  On the other hand, it’s hard to turn down the cash that clients are pleading with you to take.

–One secret to investing is to ride your winners and cut your losers.  There’s a tendency for investors of all stripes to do the opposite.  Sometimes they even sell some of their good securities to buy more of their losers.  Don’t ask me why.  My only answer is that no one likes to admit he’s made a mistake.

In particular, when a fund sees redemptions coming, I think it must sell assets across the board, with particular attention to offloading the least liquid, most losery holdings it has.  Otherwise the fund ends up making itself less and less liquid.  If brokers figure out what’s going on, which they will surely do pretty quickly, or if another fund begins to sell, these less liquid holdings may become unsalable, except at crazy low prices.  (All a broker has to do is look at your latest SEC filings or your own marketing materials to learn in detail what you own.)

–Another secret to investing, especially applicable to value investing, is to buy low. Its corollary is to sell high. Both are much harder to do than most suspect.  In fact, stock market participants typically do the opposite.  Some fund managers will even use the flow of money into their funds (or lack of it) as a contrary indicator.  They adopt a bearish stance when they’re flooded with cash and become more bullish as the buy high/sell low crowd starts to leave.  Maybe you can’t hold cash, but you can hold some highly liquid, if boring, positions.

my takeaway

I don’t know the people at Third Avenue and have no idea how they handle management of their portfolios in general or how they dealt with redemptions at the Focused Credit fund.  Even if the managers did everything by the book, my guess is that the withdrawals were so overwhelmingly large that closing the fund was the only option.

The Focused Credit demise came during a period of economic expansion.  Yes, natural resources junk bonds have been in trouble, but the general economy isn’t.  I wonder what would happen to junk bond funds in an economic downturn?





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