When the news broke that Third Avenue Management suspended redemptions in its junk bond mutual fund, it raised eyebrows and questions. Here’s a quick look at what happened and why it matters.
Disallowing the selling of shares is familiar to hedge fund investors, where such a limitation is called a gate, but for mutual funds, this kind of maneuver is exotic, and not in a good way. Mutual funds are thought of as ready-made for everyday investors; still, managers can pull the plug on redemptions without warning. We expect thousands of investors were blindsided by Third Avenue’s ugly move.
Fortunately it doesn’t happen often, but the fact that it can and in this case did, is a cautionary tale and one of several reasons why we eschew mutual funds completely. Also on the list: allowing trades only at 4 pm, no matter how volatile markets may be during the course of the day; and sticking the unpaid tax bill to any individual who buys the mutual fund, no matter when in the year they buy.
The mutual fund served a great purpose in the 20th Century, offering retail investors access to hundreds of securities with a single trade. But the investment vehicle failed to evolve with the markets and technology. That’s how the ETF emerged as such a powerful new-century alternative. The explanation for this is complex, but ultimately ETFs utilize a different structure and different redemption mechanism, which make Third Avenue style freezes impossible. Further, the ETF trades at dynamic prices all day long and minimizes capital gains tax surprises.
Knowledge is power in investing, and the Third Avenue story is one we can all learn from.