December 16, 2015

Investors may soon find themselves caught in a prisoners' dilemma

"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 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.

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.

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.



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

"...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.

Read more at http://www.businessinsider.in/Investors-may-soon-find-themselves-caught-in-a-prisoners-dilemma/articleshow/50192151.cms

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