Description

Overview

The Avenue Income Credit Strategies Fund (ACP) is a closed-end fund that trades at a 15% discount to NAV.  In addition to the discount, the underlying assets are attractively priced due to forced selling by open-ended vehicles with overlapping holdings.

Discount to NAV

ACP is currently trading at a 15% discount to NAV.  This is attractive relative to the fund’s own trading history and to CEF discounts in general.  However, with the recent stress in the market, it’s not uncommon to find CEFs with discounts in the mid-teens, so while the discount is nice, it’s not reason enough for the fund to be attractive.

Attractive Asset Class

ACP, like its manager Avenue Capital, focuses on distressed assets.  The fund is primarily focused on assets rated CCC and below:

As of 12/31/15

Spreads in CCC and below have blown out much wider than in the higher tiers of junk.  See below for a comparison of CCC and below spreads vs. single Bs:

CCC and below spreads have blown out to ~20 points, a move far more dramatic than that seen in single Bs (or higher).  Spreads have eclipsed those seen during the 2011 Eurozone crisis and are now at the highest levels in recent history, outside of 2008.

Technical Selling

Maybe the fall in prices has been entirely justified by the collapse in energy and the shakier fundamental backdrop.

However, I have some confidence that there is a large technical component to the selloff.  This has to do with widespread redemptions in open-end vehicles in the same space.

At the end of last year, redemptions at the Third Avenue Focused Credit Fund (TFCIX) caused the fund to close, an unprecedented move in the open-end mutual fund space.  Redemptions and fund closures have also been seen in the hedge fund space where there was quarterly liquidity (e.g. Claren Road, Stone Lion, etc).

Avenue manages an open-end mutual fund with a similar mandate to the Third Avenue Fund: the Avenue Credit Strategies Fund (ACSBX, the PM of which also manages ACP and used to manage the Third Avenue fund until 2012). In the wake of Third Avenue’s liquidation, the Avenue open-end fund has come under pressure and seen significant redemptions as investors have shunned similar strategies.

It’s a bit of a prisoner’s dilemma: investors in the fund would probably be best off by holding on to these assets at (now) attractive prices, but the worry is that enough other investors will redeem that the fund gets liquidated and you are left behind when the gates close.  As a result, investors have been redeeming without regard for the valuation of the underlying assets. This is clearly non-fundamental selling.

The Avenue open-end fund had lost about half its assets when it stopped daily reporting of fund assets: http://www.cnbc.com/2016/01/11/reuters-america-update-2-exclusive-billionaire-lasrys-junk-fund-stops-voluntary-reporting-of-asset-levels.html

There is significant portfolio overlap between the Avenue open- and closed-end funds.  The open-end fund was/is much larger, having gone from 2B to 600-700M, while the CEF has been around 220M.  About 70% of the CEF fund assets (on a credit basis) are also held in the open-end fund.  As the open-end fund has had to meet redemptions, this has put downward pressure on its holdings, providing buyers of the CEF with a double discount: a 15% discount to NAV, where the NAV is depressed due to redemptions from the open-end vehicles.

Some Relevant Stats

Energy exposure makes up 8.5% of assets (producers and services combined)

Level 3 assets are 3.2% of assets

The fund can employ leverage up to 1/3 of assets, so assets have had to be sold to keep leverage in line during the downdraft. This could continue if prices continue to decline.

Catalyst

End of redemption/liquidation cycle