SEC Probes High-Yield Funds in the Wake of Third Avenue’s Junk Bond Fund Collapse, Says Reuters

Reuters is reporting that the Securities and Exchange Commission is examining the possible liquidity risks involved in high-yield bond funds. The probe comes following the collapse of the Third Avenue’s Focused Credit Fund (TFCVX) in early December. That has been touted as the largest mutual fund failure since the financial crisis of 2007.

The fund failed because of its inability to meet so many investor redemption request following heavy losses in the junk bond market. When the fund couldn’t find more buyers, it ended up having to suspend the redemptions and liquidate.

Now, regulators want to look into the ways in which mutual funds deal with liquidity risks and how such disruptions can impact not just shareholders but also the wider market. Reuters said that last month the SEC notified mutual funds and exchange-traded funds that it wants information about how securities that are less liquid are priced and whether certain parties have questioned these prices.

In particular, reports the news agency, the Commission has specifically asked for daily internal illiquidity calculations from 8/31/15 to 12/15/15, the names of large fund shareholders, disclosures related to liquidity, redemption activity, portfolio composition quality for each fund, and the daily outflow and inflow of information. Fund mangers were reportedly given only 24 hours to provide a little over half of the information requested and another week to hand over the rest of the documents.

The Focused Credit Fund’s failure has brought up new concerns over whether there are adequate protections to cushion the marketplace should a fund have no choice but to unwind. There is also questions about whether stricter rules need to be implemented to make sure investors are properly protected from risks in the liquidity market.

The Commission has been trying to reduce these risks. It even proposed new rules calling on ETFs and mutual funds to review liqiuidy risks periodically, as well as classify portfolio liquidity.

The SEC’s Office of Compliance Inspections and Examinations, when listing its 2016 examination priorities, said that the agency intended to further examine mutual funds, ETFs, and private funds exposed to fixed income securities that are potentially illiquid.

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US SEC reviews high-yield funds following Third Ave blowup, Reuters, January 13, 2016

SEC Outlines ETF Plumbing as Priority for Investigation in 2016, Barron’s, January 11, 2016