It Starts: Junk-Bond Fund Implodes, Investors Stuck

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It Starts: Junk-Bond Fund Implodes, Investors Stuck
by Wolf Richter • December 11, 2015


[font color="blue"]And the next crisis hasn’t even begun yet.[/font]

We have warned about “open-end” bond mutual funds, particularly those with a lot of high-yield bonds. We know some folks who got burned when Charles Schwab’s $13-billion bond fund SWYSX blew up during the financial crisis and lost 60% or so of its value before its data went offline.

Schwab settled all kinds of class-action and individual lawsuits for cents on the dollar. It got in trouble over other bond funds. And other purveyors of bond funds got in trouble too.

It works like this: When an “open-end” bond fund starts losing money, investors begin to sell it. Fund managers first use all available cash to pay investors. When the cash is gone, they sell the most liquid securities that haven’t lost much money yet, such as Treasuries. When they’re gone, they sell the most liquid corporate paper. As they go down the line, they sell bonds that have already lost a lot of value. By now the smart money is betting against the fund, having figured out what’s happening. They’re shorting the very bonds these folks are trying to sell.

The longer this goes on, the more money investors lose and the more spooked they get. It turns into a run. And people who still have that fund in their retirement account are getting cleaned out. ................(more)

http://wolfstreet.com/2015/12/11/junk-bond-fund-implodes-investors-stuck-focused-credit-fund-by-third-avenue/