Markets / 14 December 2015, 11:47am / John Gittelsohn
New York - Top bond investors are predicting more carnage for high-yield funds amid a market rout that forced a Third Avenue Management mutual fund last week to freeze redemptions.
Scott Minerd, global chief investment officer at Guggenheim Partners, predicts 10 percent to 15 percent of junk bond funds may face high withdrawals as more investors worry about getting their money back. He joins money managers Jeffrey Gundlach, Carl Icahn, Bill Gross and Wilbur Ross in warning of more high-yield trouble ahead.
“The risk is that this is going to cascade into something bigger,” Minerd, whose firm oversees $240 billion, said in an interview at his oceanfront office in Santa Monica, California. “If we’re going to see contagion, the most vulnerable funds are going to be the ones that are down significantly.”
Debt of struggling companies has slumped, with one market gauge falling to a six-year low, as declining energy and commodity prices hit producers just as the Federal Reserve prepares to raise borrowing costs for the first time in almost a decade. Third Avenue said last week it was liquidating a $788.5 million corporate debt mutual fund and delaying distribution of investor cash to avoid bigger losses. Stone Lion Capital Partners said it’s suspending redemptions at a $400 million credit hedge fund after clients asked to pull too much money.
Third Avenue is parting ways with CEO David M. Barse, the Wall Street Journal reported, citing unidentified people familiar with the matter. Daniel Gagnier, a spokesman for Third Avenue, declined to comment when reached by Bloomberg. Barse didn’t respond to messages left at his home over the weekend.
The SPDR Barclays High Yield Bond ETF, a proxy for the market, fell 2 percent on Friday, its biggest one-day drop in four years, and closed at its lowest level since July 2009. Many funds had bigger losses, and shares of most high-yield exchange-traded funds were trading below the value of their assets.
Shares of the $211 million AdvisorShares Peritus High Yield ETF declined 4.3 percent, the second-worst performer among 44 US high-yield ETFs tracked by Bloomberg. The fund, which is down 15 percent this year, was trading at a 4.8 percent discount to the value of its assets. The ProShares Ultra High Yield ETF was the worst performer, declining 5.8 percent on Friday and 16 percent this year. The fund, which has shrunk to just $2.4 million in assets, traded at a 6.5 percent discount.
Icahn, a billionaire who has been betting against high- yield, has criticised high-yield ETFs for giving less sophisticated investors easy access to a market whose risks they may not fully understand. He said in a post on Twitter Friday that the selloff in the debt is only getting started.
Unlike hedge funds or private equity funds, where investor money is locked up for longer periods, mutual funds are required to let clients pull out on a daily basis, and ETFs even provide intraday liquidity. That makes them less suitable to invest in hard-to-sell assets.
The Third Avenue Focused Credit Fund in many instances had purchased 10 percent or more of smaller bond offerings. Such large positions in infrequently-traded debt can make it difficult to exit. Third Avenue was the biggest holder of one set of bonds issued by bankrupt power producer Energy Future Holdings Corp., according to data through July 31.
Hedge funds, like the Stone Lion fund, typically have more time to realise gains in such investments, but they can also take more risk and they often use leverage, or borrowed money, to amplify gains. If a trade goes wrong, that leverage will leave them with bigger losses.
‘Never one cockroach’
“The real question is going to be how many hedge funds go bankrupt,” Gundlach, whose firm oversees $80 billion, said in a telephone interview from Los Angeles. “There’s never one cockroach. There’s never just one portfolio that’s mismarked.”
Ross, chairman of WL Ross Holding and a well-known investor in distressed businesses including steel, said Third Avenue and its founder Martin Whitman may have been the victims of a changing market and regulatory environment.
“Because of Dodd-Frank and other regulatory pressures all trading desks are deploying less capital than ever before and this is creating tremendous illiquidity and volatility,” he wrote in an e-mail. “There will likely be other Marty Whitmans.”
While many funds may face temporary liquidity problems, the fundamentals in the high-yield market are still in good shape, according to Michael Buchanan, deputy CIO at the $446 billion Western Asset Management. The $347 million Western Asset Global High Yield Bond Fund, which Buchanan co-manages, is down about 5 percent this year.
“The message from our standpoint is if you own it already, hang tight,” Buchanan said in a telephone interview. “If you don’t own it, this is a good time to think about adding some exposure, especially if you’re a value-oriented, long-term investor. I think there’s real opportunity in the market.”
For Oaktree Capital Group, the world’s biggest distressed-debt investor, the market is presenting the most investment opportunities since Lehman Brothers Holdings Inc. collapsed in 2008, according to co-Chairman Howard Marks.
“For the credit investor we have our first opportunities in several years,” Marks said on December 8 at a Goldman Sachs Group Inc. conference in New York. “It’s been a long, long time.”
Others say its still too early to buy after the recent declines. Meridee Moore, who started Watershed Asset Management 13 years ago, is returning client money in her $1 billion hedge-fund firm, citing the difficulty of finding good investments in distressed companies.
“The last eighteen months have seen grinding declines in stressed and distressed credit and special situations equities,” she wrote in an investor letter dated November 30. “But even though market prices are lower, we have not been able to find new liquid credit investments with attractive returns and a margin of safety.”
Gross, who led the world’s largest bond fund at Pacific Management Investment before moving to Janus Capital Group last year, said investors should reduce risk following Third Avenue’s move.
“HY Fund closes exit doors,” Gross said on his Janus Twitter feed. “Who will get in if you can’t get out? Risk off.”
Investors who have lost patience may decide to pull their money before the end of 2015, causing trouble for more funds, according to Guggenheim’s Minerd.
“A lot of people have just shut their books for the end of the year,” he said. “There’s this very narrow window here, where if people decide that it’s time to reduce risk and take tax losses, that the market has a structural problem.”