Investment managers are entrusted with other people’s money, so you want to ensure (or, at least promote) best practices and good outcomes. As part of our ongoing efforts to vet and review investment managers, we pay attention to a variety of legal, legislative, and business action - lawsuits, legislative updates, ownership changes, D.O.L. guidance – looking for signs of misconduct within the industry. Naturally, we’ve been following the class action lawsuit against Third Avenue’s high yield product, the Focused Credit Fund. On December 10th, Third Avenue closed down the fund, suspended redemptions, and began a sell-off of assets. Apparently, the S.E.C. was displeased about the lack of advance notice to investors. Now, the S.E.C. is overseeing the shuttering of the fund, selling off the assets over time, so as not to saturate the demand and lower prices, while returning cash to the investors. The slow sell off is particularly necessary in this case since the high yield bond fund picked up a substantial amount (70% according to Dow Jones MarketWatch) illiquid, distressed, unrated junk-bonds that aren’t very liquid, and cannot quickly be turned into cash.
All of this is an unwelcome headache for Third Avenue. Their CEO, David Barse, resigned on December 14th. Morningstar qualitative analysts are lowering their grade (from a “Neutral” to a “Negative”) for the fund family across the board. In a specific sense, Third Avenue has to go on watch. In a broader sense, this action should give investors pause about non-traditional and alternative mutual funds. Accountants in the audience – those who are familiar with the concept of Level I, II, and III assets – will understand the importance of daily liquidity of underlying assets if you have a mutual fund which is ostensibly accurately priced every day. There are plenty of so-called liquid alternative funds with daily updates on price but which carry assets difficult to evaluate. In times of stress, and substantial redemptions, it can be hard to allow these exotic assets into an investment vehicle – a mutual fund – which promises daily liquidity.