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December 11, 2015 at 10:45 AM
Investors who piled into the riskiest corners of the credit markets during seven years of rock-bottom interest rates are getting a reminder of how hard it can be to cash out.
With outflows from U.S. high-yield bond funds running at the fastest pace in more than a year, Martin Whitman’s Third Avenue Management took the rare step of freezing withdrawals from a $788 million credit mutual fund on Dec. 9. The firm’s assessment that meeting redemptions would be impossible without resorting to fire sales has put a spotlight on the dangers for junk-bond investors as the Federal Reserve prepares to lift interest rates as soon as next week.
“It’s definitely a dark cloud over the market,” said Anthony Valeri, a strategist at LPL Financial, a Boston-based financial-advisory firm. Investor withdrawals “are driving the high yield market now more than anything. Institutions — hedge funds and mutual funds — are being forced to get out and unfortunately that’s pressuring the entire market.”
The selloff in riskier debt, fueled by tepid global economic growth and a collapse in earnings at commodity companies, deepened on Thursday as news of Third Avenue’s decision rattled investors. Yields on U.S. high-yield debt climbed to the highest in almost four years, putting the market on pace for its first annual loss since 2008, a Bank of America Merrill Lynch index shows.
Growing tumult in credit markets comes eight years after BNP Paribas SA helped spark a global financial crisis by freezing withdrawals from three investment funds because it couldn’t “fairly” value their mortgage holdings. While Third Avenue said its positions have the potential to deliver returns over a longer investment horizon, Berwyn Income Fund’s George Cipolloni said the similarities between today’s markets and those before the crisis are getting too big to ignore.
“A lot of this looks like late 2007 or early 2008,” when the credit crunch began to take root, said Cipolloni, whose fund has outperformed 72 percent of peers tracked by Bloomberg over the past five years. “But instead of housing and mortgages, it’s energy and materials leading the decline.”
Third avenue declined to comment beyond what was in its statement, Daniel Gagnier, a spokesman, said Friday.
Debt-laden commodity producers have been some of the hardest hit parts of the junk-bond market this year as prices for everything from oil to steel tumbled on signs of oversupply and weak demand from China. The slump is burning investors who relied on lower-rated bonds to boost returns as the Fed kept its benchmark interest rate near zero since 2008.
Many funds have also taken on greater liquidity risk in their hunt for higher yields. 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. That’s particularly been the case in recent months as the aversion to commodities- industry borrowers spread to almost any debt that smacked of risk.
At the end of July, it held about a third of distressed tween-jewelry retailer Claire’s Stores Inc. $320 million of 7.75 percent bonds. Those securities lost almost half of their market value after just two trades on Dec. 1.
