Articles Posted in Junk-rated debt funds

In the wake of news that the junk bond fund Third Avenue Focused Credit Fund (TFCVX) is now blocking money redemption, investors have started to worry about similar investments. The inability of TFCVX to give investors their money back is raising concerns about liquidity in corporate bond markets, as well as questions about how problematic it can be when investors have high risk assets that no one wants to buy (a problem that was at the center of the 2008 financial crisis).

What are Junk Bonds?
So called “junk bonds” are bonds that have been rated below investment grade by the major rating agencies (i.e., below BBB by S&P). These bonds typically pay more than higher rated bonds, but they are high risk and can default or lose significant value in a short period. People tend to invest more money into junk bonds when the economy is doing well, and, as has been the case for a number of years, interest rates on more traditional bonds or fixed income investments are low. However, when junk bonds start defaulting or get further downgrades, investors are forced to realize significant losses, often in very short periods.

In the wake of Third Avenue Focused Credit Fund’s collapse, there are those who are worried that more funds, including hedge funds and mutual funds, may follow. For example, a hedge fund managed by Stone Lion Capital Partners also recently decided to suspend redemptions. You can read more about that here.

InvestmentNews recently put together a list of 10 credit funds that, according to Morningstar, have a high level of exposure to junk bonds:

· Federated High Yield Service (FHYTX)
· Waddell & Reed High-Income A (UNHIX)
· Osterweis Strategic Income (OSTIX)
· Fidelity Advisor High Income Advantage A (FAHDX)
· Ivy High Income C (WRHIX)
· Third Avenue Focused Credit Instl (TFCIX)
· Artisan High Income Advisor (APDFX)
· American Funds American High-Inc A (AHITX)
· Western Asset Short Duration High Inc B (SHICX)
· Northern Multi Manager Hi Yield Opp (NMHYX)
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Just days after the collapse of Third Avenue Management LLC’s junk bond fund the Focused Credit Fund (TFCVX), the company’s CEO David M. Barse is out, says the Wall Street Journal. The news comes following Barse’s announcement that redemptions to the high yield mutual fund’s investors would be frozen. The media outlet says that Barse was fired and is not allowed to reenter the building.

This week, the Massachusetts Securities Division issued a subpoena saying that it was probing the fund closure and liquidation strategy. Secretary of the Commonwealth William F. Galvin, says he wants to find out to what extent the state’s investors have been affected by this “unprecedented decision.” It was on December 9 that they were sent a letter announcing that the redemptions would be stopped and the assets that were left would be liquidated.
This is an unusual move for a mutual fund. Such funds typically have to abide by tight regulations that mandate that investors be provided liquidity daily.

The reasons for the changed policy are investor net withdrawals and heavy losses in the underlying investments. There is also speculation that the large position that the Focused Credit Fund had taken in what are known as Level 3 assets, which are securities that trade so infrequently it’s hard to know exact prices, were becoming an issue. It reportedly got to the point that Level 3 assets in the portfolios went from 15% of what was held to about 25%, which regulators typically consider too high.

The New York Times reports that the decision to prevent investors from getting their money back has caused concern among the market, which have been getting ready for the Federal Reserve’s anticipated interest rate increase. The fear is that the Focused Credit Fund’s demise is not an isolated incident, and other mutual funds holding a significant number of junk bonds, emerging market debt, and leveraged debt may find themselves in the same predicament.
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According to MTS Research Advisors, non-traded business-development companies, which are junk-rated debt funds, doubled their sales to a $2.8 billion high in 2012, making $134 million in revenue. Among these was Franklin Square’s FS Investment Corp., an initial $2.5 billion fund to which investors have already paid $323.5 million in commissions and fees-25% more than the $258 million that they have received, reports Wells Fargo & Co. analyst Jonathan Bock and Bloomberg. $5,000 is the minimum investment.

While Franklin Square touts its fund as having a structure that lets investors who don’t have sufficient money buy into hedge or private-equity funds to diversify into loans to smaller companies, Bloomberg notes that Morningstar Inc. analyst Sarah Bush recently observed that about 50% of the securities held by the fund overlaps with holdings found in bank-loan mutual funds, which means that Franklin Square isn’t giving investors access to anything they wouldn’t be able to obtain via other avenues.

Non-traded business-development companies lend investors’ money to companies. They can charge high interest rates on the loans because lenders are usually rated junk or aren’t rated at all. The debt usually pays a floating rate, which means investors will make more if benchmark interest rates go up.

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