A freeze on investor redemptions in a major high-yield credit fund has sent shockwaves through the US bond markets this week with Third Avenue Management blocking investors from taking money out of its Focused Credit Fund, citing difficult trading conditions for its securities. The move by Third Avenue, which has around USD$8 billion on funds under management, has shone a spotlight on one the riskier areas of the bond market and exacerbated fears that record low interest rates has driven yield-seeking investors into junk bonds and emerging market debt that may, in turn, become illiquid if and when interest rates start to rise.
The bigger worry for markets is that a rise in official interest rates by the US Fed will see yields on junk bond shoot higher and that an investor panic to exit might cascade into a broader bond rout.
A number of well-known investors and central bankers, including the Bank of England’s Mark Carney, have warned investors that the rush to find yield coupled with new regulations that effectively stopped investment banks from running proprietary trading desks and making markets in securities means that when the interest rate music stops and investors rush for the exits, yields on bonds might shoot drastically higher. This could potentially be worse on emerging market debt or high yield credit such as junk bonds.
The Third Avenue fund freeze, coming just ahead of the US Fed’s December FOMC meeting, might be the canary in the coal mine and a portent of things to come.