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Illiquid assets at failed Third Avenue junk fund underscore SEC concerns

Published Mon, Dec 14, 2015 · 11:24 PM
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[BOSTON] Illiquid assets at Third Avenue Management's junk-bond fund skyrocketed before it imploded last week, underscoring an opaque corner of risk in the mutual fund industry that corporate governance experts worry is not policed by outside directors.

The biggest meltdown of a mutual fund since the 2008 credit crisis happened as the US Securities and Exchange Commission pushes for a 15 percent cap on illiquid assets, meaning they trade so infrequently that they do not have a market price.

The SEC's proposals made in September seek stepped up oversight from mutual fund boards and more clarity around what constitutes an illiquid asset.

Because illiquid assets are hard to price and trade, funds with elevated levels of these securities may be sitting on bigger potential losses than investors realize, according to analysts.

Often the assets are bankruptcy claims, risky mortgage-backed bonds or debt issued by a company in financial distress.

At the end of July, for example, the Third Avenue Focused Credit Fund's illiquid, or hard to market and value investments, accounted for 9.1 per cent of nearly US$2 billion in assets, according to Third Avenue regulatory disclosures. That was up from 4.6 per cent in October 2014 and just 0.91 per cent in 2012.

But when based on US accounting rules, the fund's illiquid securities were 20 percent of fund assets, fund disclosures show.

Representatives for Third Avenue and its parent firm, Affiliated Managers Group Inc, did not return messages.

Funds currently have a lot of discretion on how they label and value assets that are hard to price and trade. As it stands now, most funds rely on valuation committees of insiders to oversee assets that the SEC sees as a potential systemic risk to investors.

Third Avenue's decision last week to liquidate its nearly US$800 million Focused Credit Fund and block investor redemptions jolted Wall Street and mom-and-pop investors who have poured billions into junk funds. And it reignites what law professor William Birdthistle describes as an existential question about the oversight of management by mutual fund boards.

Mutual fund boards are set up to look out for the interests of shareholders and negotiate competitive management fees, for example. Board members can be nominated by incumbent independent directors. But some experts say these boards do too little. "Whatever you say their job is, they do a bad job of it,"said Birdthistle, a funds and governance expert who teaches at Chicago-Kent College of Law.

Growing worries about the junk bond market, which are vulnerable to higher interest rates, are rattling global markets and hurting the shares of big fund managers, with shares of No. 1 asset manager BlackRock Inc off 10 per cent in the last week.

Meanwhile, Third Avenue's long-time Chief Executive Officer David Barse has left the firm in a mutually agreed upon departure. And Massachusetts' top regulator says he wants to know if some investors knew about the decision to liquidate the fund before others.

Third Avenue's valuation committee consists of three veteran insiders: general counsel Jim Hall, Controller Jim Buono and Chief Financial Officer Vincent Dugan, disclosures show.

Calls to Third Avenue executives and outside directors were referred to Hall, who did not return several messages seeking comment.


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