In the wake of news that the junk bond fund Third Avenue Focused Credit Fund (TFCVX) is now blocking money redemption, investors have started to worry about similar investments. The inability of TFCVX to give investors their money back is raising concerns about liquidity in corporate bond markets, as well as questions about how problematic it can be when investors have high risk assets that no one wants to buy (a problem that was at the center of the 2008 financial crisis).
What are Junk Bonds?
So called “junk bonds” are bonds that have been rated below investment grade by the major rating agencies (i.e., below BBB by S&P). These bonds typically pay more than higher rated bonds, but they are high risk and can default or lose significant value in a short period. People tend to invest more money into junk bonds when the economy is doing well, and, as has been the case for a number of years, interest rates on more traditional bonds or fixed income investments are low. However, when junk bonds start defaulting or get further downgrades, investors are forced to realize significant losses, often in very short periods.
In the wake of Third Avenue Focused Credit Fund’s collapse, there are those who are worried that more funds, including hedge funds and mutual funds, may follow. For example, a hedge fund managed by Stone Lion Capital Partners also recently decided to suspend redemptions. You can read more about that here.
InvestmentNews recently put together a list of 10 credit funds that, according to Morningstar, have a high level of exposure to junk bonds:
· Federated High Yield Service (FHYTX)
· Waddell & Reed High-Income A (UNHIX)
· Osterweis Strategic Income (OSTIX)
· Fidelity Advisor High Income Advantage A (FAHDX)
· Ivy High Income C (WRHIX)
· Third Avenue Focused Credit Instl (TFCIX)
· Artisan High Income Advisor (APDFX)
· American Funds American High-Inc A (AHITX)
· Western Asset Short Duration High Inc B (SHICX)
· Northern Multi Manager Hi Yield Opp (NMHYX)
As the publication notes, these funds have the highest concentration in the lowest rated junk bonds, meaning they are the riskiest of an already risky class of securities. Many investors holding these funds may not be aware of their extreme risks. Such investments are often misrepresented at the point of sale, and, given the minimal additional income they provide, the risk inherent to them is extreme.
Top 10 credit funds with extreme junk bond exposure, InvestmentNews