Bond Funds

Are Asset Managers Vulnerable to Fire Sales? That’s the probing question of a study undertaken by two economists and an assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

The study has sounded a clear warning about the potential for mutual funds to be subject to a “run” — despite the fact that they have no significant leverage and a floating net asset value (NAV).

In addition, the study says that such a run can produce significant negative spillovers in asset markets through forced liquidations.

While the study’s authors have posted a disclaimer on the Blog post of the New York Fed’s website, that the views expressed in their post about the study, do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System, it has caught the attention of a number of national news publications, including the New York Times.

The study argues against the conventional wisdom, that an open-ended investment fund with a floating net asset value (NAV) and no leverage will never experience a run and hence never have to fire-sell assets.

According to the study, Bond funds that have a floating net asset value are in danger since early investor withdrawals from these funds leave the remaining investors at risk.  The study’s authors say that this can happen because early withdrawals are made from cash reserves or cash flow that do not consider the cost of selling illiquid assets.

Bonds held by these funds are not traded like stocks and generally have thin markets.  Fund valuation of these assets may be based on holding the bonds to maturity and do not adequately consider fire sale prices.

This is a problem, because high-yield bond funds rely on high risk bonds in the energy sector or, in the case of tax frees, Puerto Rico.  If there is a large demand for redemptions, these funds may not have sufficient cash or liquidity.

Recently, Third Avenue Management decided to liquidate its Focused Credit high-yield fund instead of meeting investor withdrawals in a timely fashion.  “The remaining assets in the fund will be put into a liquidating trust and sold off gradually, the idea being to not drive down prices too sharply,” the company said, according to a New York Times report.

Is the Third Avenue Management the canary in the coal mine?  If you have a hi-yield bond fund that has significantly dropped in value, you may have an avenue for recovery.  Contact Securities Fraud Recovery Attorney Mark A. Tepper at askmark@marktepper.com or telephone the law firm at (954) 961-0096 for an evaluation of your claim.

About Mark A. Tepper, P.A. (www.MarkTepper.com)
Attorney Mark A. Tepper has earned the reputation of “Investor Advocate” while practicing law for over 35 years representing individual investors. A member of the Florida, New York and California Bars, Mr. Tepper is peer-reviewed for 15 consecutive years, AV PREEMINENT® for ethical standards and legal ability, the highest rating of lawyers in the Martindale-Hubbell Law Directory.