BOSTON (Reuters) - In the months before the blowup of Third Avenue’s junk bond fund in early December, investors and financial advisors called the New York-based investment company to voice their concerns about the growing percentage of hard-to-trade, illiquid assets in the fund’s portfolio.

The U.S. Securities and Exchange Commission logo adorns an office door at the SEC headquarters in Washington, June 24, 2011.REUTERS/Jonathan Ernst

“I would call up and they would say, ‘We’re under control, we have plenty of cash,’” said Richard Berse, president of Northstar Financial Advisors Inc in New Jersey. But Berse, who had as much as $2.5 million in client money in the fund, got burned. Less than a month after his last call to Third Avenue Management LLC, the $789 million Focused Credit Fund abruptly blocked investor withdrawals and announced on Dec. 9 it would liquidate the fund’s assets. The extent of the losses are unclear. Brad Alford, chief investment officer of Alpha Capital Management in Atlanta, also said he told Third Avenue the fund was too volatile because it was holding too much in illiquid assets. “I just became very uncomfortable with it,” said Alford, who pulled out of the fund this summer.

The biggest mutual fund blowup since the 2008 financial crisis underscores how difficult it can be to rein in a mutual fund taking outsized risks compared with its peers, even though Focused Credit officially had many overseers. The U.S. Securities and Exchange Commission, which is now investigating the fund’s meltdown, did not get involved until it was clear Third Avenue’s only recourse was to liquidate the fund, according to people familiar with the situation. Executives at Third Avenue and its parent company, Affiliated Managers Group Inc, declined to comment or did not respond to several requests to comment for this story. When compared with other junk bond funds, Focused Credit carried an elevated amount of risk. The fund disclosed, for example, that its so-called Level 3 assets, or securities that are hard to value and trade, were 20 percent of assets at the end of July. That was higher than any other U.S. junk bond fund with at least $500 million in assets, according to a Reuters analysis of fund disclosures.

And the fund had 76 percent of its portfolio exposed to very low rated “CCC+” rated securities and below, compared with a median level of 22 percent among similar junk funds, according to analysts at Citigroup. Launched in 2009, Focused Credit found its way into the portfolios of mom-and-pop investors, pension plans and nonprofits, fund disclosures show. It differed from other junk bond funds because it favored creditor claims and stock warrants tied to companies going through bankruptcy.

One of its biggest investors was Boston-based Fidelity Investments’ Strategic Advisers Income Opportunities Fund, which had a $128 million stake at the end of October. Fidelity declined to comment on the fund’s current exposure.

Graystone Consulting, Morgan Stanley’s independent adviser to institutional and wealthy clients, originally recommended the fund in 2014 via a due diligence report that clearly highlighted the fund’s liquidity risks, Morgan Stanley spokesman James Wiggins said. Graystone then produced an updated assessment in 2015 in which liquidity risk is also highlighted, he added. “Graystone stands behind its review process. Third Avenue has a strong track record as an investment manager and has found historical success in illiquid instruments,” Wiggins said.

BLUNT AND AUTOCRATIC

Third Avenue, led by long-time chief executive David Barse, did not recognize the danger the fund was in until it was too late. In fact, fund management team members discussed internally that they believed the fund still could ride out a storm of redemptions less than 90 days before the fund’s collapse, said former and current employees who requested anonymity. Inside Third Avenue, some of the company’s 100 or so employees were unsettled by Barse’s management style, which they saw as blunt and autocratic, according to interviews with about a dozen former and current Third Avenue employees. Perhaps most importantly, Barse’s hard-charging personality made it hard for subordinates to bring him bad news, these sources said. In recent years, some even complained to AMG, the parent company of Third Avenue, but Barse, who had led the firm more than two decades, remained firmly in control.

Barse sometimes berated employees in front of colleagues, reducing them to tears, according to the current and former employees. In the months before Focused Credit’s collapse, key people jumped ship as the fund hemorrhaged assets, declining to less than $1 billion from more than $3 billion in 2014. Three of Focused Credit’s eight-member team, for example, left during the first half of 2015, according to current and former Third Avenue employees. Barse, 53, did not return messages seeking comment. He made a positive impression in some circles. Barse is a trustee of Brooklyn Law School, where he graduated in 1987. The chair of the school’s board, Stuart Subotnick, said he didn’t know what to make of the criticism. “David is a tough guy. I would imagine there are a lot of guys in that business who are jealous of him or don’t like him, and this was an opportunity to dump on him,” Subotnick said. AMG Chairman Sean Healey, who declined comment for this story through a spokeswoman, personally got involved in the discussions that led to what the two sides ultimately described as Barse’s mutually agreed departure from the firm after the junk bond fund’s demise, according to people familiar with the situation. Under Barse’s direction, assets at Third Avenue peaked at $26 billion in 2006, but by the time of his departure managed assets had dwindled to about $8 billion. And investment advisory fees at the firm’s flagship Value Fund were just $22 million in the fiscal year ending Oct. 31, 2014, down 77 percent from $97.2 million in fiscal 2007, fund disclosures show. “I hope you appreciate that David and everything he stood for are being disassociated from the fund,” said Martin Shubik, an 89-year-old Yale University economist who is an independent director for the Focused Credit Fund.

Five of the fund’s six other independent directors did not return messages or referred questions to Jim Hall, Third Avenue’s general counsel, Hall did not return messages seeking comment. The sixth director could not be reached.

DEAN OF DISTRESSED INVESTING

The board charged with oversight of Third Avenue’s five mutual funds, including Focused Credit, largely allowed Barse and his top lieutenants to run operations as they saw fit. That’s according to past and current employees who had direct knowledge of interactions between Barse’s team and independent fund board directors.

Some mutual fund experts criticize outside directors, in general, for not challenging investment company management teams. It’s not uncommon, for example, for some directors at large mutual fund companies to sit on the boards of dozens of funds and to receive fees from each in what critics call a cozy rubber stamping operation for management. “People know what side their bread is buttered on,” said Alan Palmiter, a Wake Forest University professor who studies the fund industry.

Founded in 1986 by Martin Whitman, now 91, Third Avenue prides itself on finding deep value in beaten-up securities. “Cheap and safe” is the company’s guiding principle. Whitman, considered the dean of American distressed investing, remains chairman and a portfolio manager at Third Avenue. He did not return messages seeking comment. Whitman, Barse and other top executives sold their controlling stake to AMG in 2002. But day-to-day operations did not change. A cornerstone of AMG’s approach is operational autonomy and independence, allowing principals such as Barse to run fund operations.

“That’s their business model and if they change it, no one would ever sell to them again,” said billionaire investor Mario Gabelli, who founded fund management firm GAMCO in 1977.