Junk bond managers battle fallout from Third Avenue fund blowup

BOSTON, Dec 11 (Reuters) - 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 shocked a junk bond market already dealing with limited liquidity and a rout in high-yield energy bonds. Mom-and-pop investors were expected to extend their run of yanking money from junk bond funds, while creating opportunities for hedge funds and insurance companies that might have more wherewithal 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.”

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, which announced this week it would block redemptions and liquidate assets amid heavy losses on bets tied to distressed companies. They acknowledged plenty of mom-and-pop investors will read the headlines and pull their money out of junk bond 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.

But Hopper said his fund is nothing like the one that failed at Third Avenue.

Third Avenue’s Focused Credit 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.

Hopper said he has been making moves for months to make his fund’s portfolio more liquid and diversified. Investments in the emerging markets of Ethiopia and Mozambique, for example, have been sold in recent months, he said.

“They represented investments that were reasonably liquid, but had a risk of becoming less liquid,” Hopper said.

Shares of publicly-traded mutual fund management companies such as Franklin Resources Inc have also taken a beating as investors worried about a growing crisis in the junk bond fund market. Shares of the parent of Franklin Templeton funds fell 6 percent to $36.16 in Friday afternoon trading.

The Franklin High Income Fund’s 9.12 percent negative return this year is worse than 98 percent of peers. The $5 billion fund has been hurt by wrong-footed bets in the junk bond market and a steady stream of net withdrawals by investors, according to Lipper Inc data. (Reporting By Tim McLaughlin; Additional reporting by Ross Kerber in Boston; Editing by Tom Brown)