Junk bond managers battle fallout from Third Avenue fund blowup

BOSTON U.S. junk bond fund managers said on Friday they are shying away from big cash trades after liquidity in the high-yield market took another hit from the meltdown of the Third Avenue Focused Credit Fund.Third Avenue's decision this week to block redemptions and liquidate a fund with $789 million in assets jolted Wall Street and caught the attention of the U.S. Securities and Exchange Commission."We are in communication with representatives of the fund and are currently monitoring the situation," an SEC spokesperson said. The junk bond market is already reeling from a meltdown in the energy sector as oil prices fall below $40 a barrel.Retail investors were expected to extend their run of withdrawals from junk bond funds, while creating opportunities for hedge funds and insurance companies that might have more ability to stomach the fallout."Liquidity is bad," said Gershon Distenfeld, portfolio manager of AllianceBernstein's $5.8 billion High Income Fund. "It is marginally worse than it was a month ago, but much of the decline in liquidity has been much steeper since the (2008) credit crisis."Pain was also being felt by hedge fund managers. Stone Lion Capital Partners LP, a manager of $1.3 billion that specializes in distressed debt, has suspended redemptions in one of its funds after "substantial redemption requests," the firm said in a statement on Friday.LionEye Capital, a $1.5 billion event-driven hedge fund, is closing its doors at the end of December after suffering double digit losses and heavy redemptions this year, two people familiar with the matter said.Most of the trading in the junk bond market is being done by exchange-traded funds, Distenfeld said."There's not a lot of cash bond trading on deals of $2 million to $3 million and up," he added. "It's not zero. There's some trading, but it's too costly to trade big size." Meanwhile, several junk bond fund managers interviewed by Reuters sought to distance themselves from the Third Avenue fund. They acknowledged plenty of retail investors will read the headlines and pull money from junk funds. "The headlines get too much for them and they tend to sell at the absolute worst time," said Greg Hopper, who runs the $1.1 billion Aberdeen Global High Income Fund. The fund's total return this year of minus 6.86 percent is lagging 94 percent of peers, according to Morningstar. Investor withdrawals have helped cut the size of his fund nearly in half this year. Third Avenue's fund had nearly half its assets in below "B" rated debt, compared to the peer average of just 12 percent, according to Morningstar Inc data. Still, "There's never just one cockroach," DoubleLine Capital Chief Executive Officer Jeffrey Gundlach said. "People are too long credit and the credit is melting down and the stock market is whistling through the graveyard. It is so similar to 2007, it’s scary." "Investors should look closely at what they are holding in fixed income and should certainly look closely at their credit exposure in high yield funds," Todd Rosenbluth, director of mutual fund and ETF research for S&P Capital IQ. "There are concerns that junk bond defaults will rise, and they will rise modestly in the next year, from a historically low level now."Hopper said in recent months he has sold investments in the emerging markets of Ethiopia and Mozambique to boost his fund's liquidity."They represented investments that were reasonably liquid, but had a risk of becoming less liquid," Hopper said. Shares of fund companies such as Franklin Templeton parent Franklin Resources Inc have also taken a beating amid growing worries about the junk bond fund market. The company's stock closed down 6 percent to $36.18 in Friday trade. The popular Franklin High Income Fund, down 9.12 percent this year, is underperforming 98 percent of peers. The $5 billion fund has been hurt by wrong-footed energy bets and heavy redemptions, according to Lipper Inc. (Reporting By Tim McLaughlin; Additional reporting by Ross Kerber in Boston; Jennifer Ablan, Richard Satran and Trevor Hunnicutt in New York; and Lisa Lambert in Washington; Editing by Tom Brown)