+

Cookies on the Business Insider India website

Business Insider India has updated its Privacy and Cookie policy. We use cookies to ensure that we give you the better experience on our website. If you continue without changing your settings, we\'ll assume that you are happy to receive all cookies on the Business Insider India website. However, you can change your cookie setting at any time by clicking on our Cookie Policy at any time. You can also see our Privacy Policy.

Close
HomeQuizzoneWhatsappShare Flash Reads
 

Investors may soon find themselves caught in a prisoners' dilemma

Dec 15, 2015, 21:13 IST

Flickr/Drewdlecam

The high-yield debt market has been experiencing a dramatic sell-off over the last few days after the closure of the Third Avenue Focused Credit Fund.

Advertisement

Investors yanked $2.8 billion from junk-bond mutual funds last week alone, according to UBS. The selling pressure has moved from the riskiest bonds to higher-rated high-yield bonds.

A fund that tracks the debt of riskier corporate borrowers -the iShares iBoxx $ High Yield Corporate Bond ETF - has fallen to its lowest level since early 2009.

The sell-off is in part a reaction to the Third Avenue closure and its decision to suspend redemptions. That means that investors who were expecting to be able to take their money out of the fund quickly and easily now have their cash locked up while the fund tries to manage an orderly wind-down.

Can't get out

Of course, that then freaks out other investors worried that the same thing might happen to them. Bill Gross tweeted out last week: "HY Fund closes exit doors. Who will get in if you can't get out? Risk off."

Advertisement

In a note released Tuesday morning, UBS analysts Matthew Mish and Stephen Caprio examined what could happen to investors as funds halt investor redemptions in order to stay liquid.

Bill GrossJanus

"Previously regulators have proposed (pre-emptive) redemption restrictions to reduce the risk of a redemption run, but imposing gates (retroactively) raises the question of whether such action will contain or exacerbate the risk," the analysts wrote.

There are two risks at play here. One is a classic prisoners' dilemma. The worry is that once one investor starts taking out money, other investors will see them and take their money out too.

"Investor redemptions create a prisoners' dilemma in which the potential for other investors to withdraw funds may lead to a self-fulfilling run on fund assets," the note said.

The second issue has to do with the cold hard cash available to funds during a period of market stress.

Advertisement

"...failures of some funds may lead prime brokers, given information asymmetries, to re-appraise risk and tighten funding conditions for other like funds."

Welcome to the feedback loop.

NOW WATCH: JIM CRAMER: 'YOU SHOW UP AND THAT'S THE REVENGE'

Please enable Javascript to watch this video
You are subscribed to notifications!
Looks like you've blocked notifications!
Next Article