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John Cole Scott is a portfolio manager at the firm and holds the Series 66 FINRA Licenses. In 2002 he earned the Certified Fund Specialist designation (CFS). For over a decade John has specialized in closed-end fund research, analysis and trading. He has been quoted or interviewed by Bloomberg,... More
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  • Discounts & Yield - CEFs For Equity & Bond Income - Morningstar Conference Panel

    This Panel was held at Morningstar's 25th Anniversary Investment Conference in Chicago on June 14, 2013. It was moderated by Mike Taggart, head of US closed-end fund research at Morningstar.

    Taggart: On the panel with me today, I'm very pleased to have Rob Shaker of Shaker Financial, Patrick Galley from Rivernorth Capital. Patrick is a founder and portfolio manager at Rivernorth. They run several funds that have closed-end fund strategies in them and John Cole Scott, portfolio manager and EVP at Closed-End Fund Advisors (CEFA), a registered advisory firm that also offers a closed-end fund newsletter, which is available for free, on their website.

    The question on most people's minds is quantitative easing and what happens to closed-end funds when interest rates start to rise. Are you concerned?

    Galley: Yes. About two-thirds of the closed-end fund space or about 400 out of 600 closed-end funds that are out there are fixed income focused and oftentimes, those closed-end funds implement leverage in their capital structure so are interest rate sensitive investment vehicles and investors know that.

    What's really interesting, unlike in 2004. Where it was really the short end of the yield curve that was moving up, presently it is the long end of the curve where interest rates are rising. That's actually a good environment for the CEF market. We're talking about the steepening of the yield curve, where the funds are borrowing in short-term, very low rates, and investing in the longer end of the curve.

    With the recent move in interest rates, we've had a sentiment shift away from fixed income. You have a discount component in closed-end funds, not only is the net-asset value (NYSE:NAV) going down presently, but now the discounts are widening quite a bit as well. For us, this is actually an opportunity as Rivernorth is an opportunistic investor in closed-end funds. We're buying when everybody is selling and the discounts are widening out and we're selling as everybody is buying in the discount scenario.

    Scott: I would agree. We're not concerned yet about leverage at the fund level. What we're really thinking about presently is investor's sentiment about what that leverage means for CEFs, what duration means for the bond funds. I think there are some great values right now.

    Shaker: CEFs are a great vehicle to be able to gauge what sentiment is doing and how sentiment is affecting market price. It's something that is very unique to closed-end funds and a great vehicle so that you can take opportunities as they present themselves.

    Instead of being concerned with the rising interest rates, the focus should be on the effects of a steeper yield curve on the CEF's portfolio and that could be a positive effect. Where closed-end funds are today, we think it's definitely a better environment than it was a couple of weeks ago.

    While we're on the topic of leverage, most closed-end funds do use leverage. Therefore, a lot of investors don't even consider closed-end funds because of the volatility that happens with the leverage. First you want to make sure you understand the leverage is there and you want to see how it affects the volatility.

    I would say the leverage is important because you figure out how net investment income will be squeezed at some point but the trading of a CEFs market price is more important of a factor to understand than just the leverage effects on NAV.

    When building your portfolio, instead of using a standard mutual fund - you can use a closed-end fund and that gives you the opportunity to have the extra variable, your knowledge of the NAV and the discount.

    Taggart: How do you actually determine whether or not what a closed-end fund should go into your portfolio. How do you go about assessing the discount and other factors you might consider?

    Shaker: At Shaker Financial, we manage several managed accounts with balanced portfolios. Instead of using ETFs or mutual funds, we use closed-end funds. What we do is called "discount capture". We try to fill an account with a closed-end funds that we believe are at artificially wide discounts. If we can then replace it later, once the discount it narrows, we can capture one or two discount points. We then can potentially replace it with a different fund that is now at a historically wide discount.

    There are a lot of ways you can analyze a CEFs historical average discount. There's a lot of things that will move that but if you're patient and you have something, even as generic as a six-month average discount to help you get your entry point or your exit points. Knowing what that is, you'll be able to take opportunities from periods like now when fixed income seems to be artificial wide.

    Taggart: I would just note that you guys don't invest in closed-end funds based simply on their published discounts?

    Galley: For us, it's not just buying the deepest discounted closed-end funds because there's probably a reason on why something's trading at a 15% discount. We have ETFs or a sub-advisors to marry our closed-end fund strategy with. As discounts widening out, we sell ETFs, buy closed-end funds, as discounts narrow, sell closed-end funds, lock in that excess return and buy the ETF.

    Scott: At CEFA, we have separately managed accounts with seven different investment models or objectives. We analyze a CEF using three main factors. One is what has been the one year net asset value total return vs. peer-funds and what is our anticipated trajectory based on our firm's view of the credit and equity markets.

    Second, we then, look at the sustainability of the dividend. Is it reasonable? Is it maintainable? How does it look compared to its peers? Is it lower than normal, higher than normal. Third, we look at the discount that the fund is currently showing. We tend to focus on one-year Z-stats, the 90 day relative discounts and current peer-group comparable discounts.

    Is it cheap? If it is cheap, why is it cheap? Is it because of a news item?, a change in the market? or just a bad manager or performance? If you can answer those questions, I think you have a much better forward-looking trajectory for a closed-end fund portfolio.

    Taggart: Just to kind of sum up and one of the reasons that I really appreciate these guys work and why we asked them to be on the panel is because they really understand the point that serious closed-end fund investors don't simply buy a closed-end fund because it's trading at an 8% discount. If you buy a closed-end fund if it's trading at say an 8% discount, its historical average might be a 12% discount then you're buying it relatively expensive to what it normally trades.

    The other thing, you all mentioned is that you keep an eye and do this quantitative stuff. By the way, they use a lot of quantitative screens as well. It's what they do day-to-day. There are a lot of people with closed-end funds who think that they're more of a trading vehicle and that they're not buying and hold. Are CEFs suitable for advisers to put into a client's portfolios as buy and hold investments?

    Shaker: We don't buy and hold because what we're all about is tactical swapping as much as we can, as fast as we can. We're trying to get as much alpha generated as possible but that does not mean that it can't be used in a buy and hold situation. The important thing to remember, is if you are going to buy and hold, then you need to stay true to that concept.

    If you didn't know, in the last week, after the tapering fears came out, fixed income closed-end funds got sold off dramatically. You had a generic widening of about 5% or 6% across the board for these CEFs. This "carnage period" in closed-end funds, is not the time to sell; that's the time to buy or hold on to what you bought because you knew this was possible.

    CEFs are a good vehicle for buy and hold but you just have to remember where you bought it. Closed-end fund investors are buy and hold until they're not. They're buy and hold for the yield, for the income and it's great. Frankly, now we're even getting a higher yield because now that closed-end fund is sold off. The NAV sold off and in fact and sometimes it can be a double discount. You're getting very attractive asset classes at good prices and you're getting attractive market prices, meaning at discount to those net asset values.

    Taggart: That's why a CEF investor should be a total return investor in closed-end funds and not just yield-based investors.

    When people are selling off CEFs, selling their shares, stampeding through the exit, these are three of the guys who are standing on the other side taking the trade. If you're wondering about their performance, I think Patrick's five-star performance on the Rivernorth Core Opportunity Fund attests to the fact that over time, that strategy pays off. John, buy and hold?

    Scott: If this conference had been a month ago, we'd be saying the discounts are relatively narrow, the bond fund returns had been strong, and for advisors to be protective on the downside for the CEFs they currently held. Well, that's not today's panel. It's the -5% discount average world we presently live in vs. a +2% to +3% premium. We could fall further, but based on the last five years, we're presently considered a relatively cheap place for CEFs. If you like the manager, you can then worry less about the volatility. If you have our resources maybe you trade off volatility actively, but you don't have to have this access to make money in a CEF.

    Galley: When the volatility starts increasing, all of a sudden, those underlying assets start depreciating, premiums can become discounts. We find the IPO investors are the first ones to bail. You have closed-end funds that just went public a few short months ago. They were at 5% premium. Today, some of them are 5% to 10% discounts. Those investors are not very happy buying at IPO.

    On a historical basis, Rivernorth has participated in two IPOs since 2004. We very rarely will participate in an IPO. The only reason we did is because we believe that the premium will actually go higher, when we compare it to other funds in the same asset class and also by the fund sponsor.

    Taggart: Right now, there are five closed-end funds IPOs pending in the market. This year, we're on track to have the most IPOs in the closed-end fund space since 2011. John Cole Scott and I have very different views on the closed-end fund IPOs. John, can you just follow-up with Patrick on closed-end fund? Have you ever invested in a CEF IPO?

    Scott: We never have. Part of that comes from our perspective of wanting to trade a close-end fund based on how it's traded against itself and its peer group. Also, knowing what type of securities it owns, what its undistributed net investment income (UNII) trend is looking like on the balance sheet for a bond fund, what its duration figure, etc. You simply can't do that with an IPO.

    By definition, it's not just disliking the IPO because some IPOs do prove successful. We did a study from 1991 to present, we found 50 IPO CEFs that had tracking ETFs so we could try to net out much of the market exposure, not the leverage - but sector trends. For the average fund we found that if you wait about nine months, you get about a 7.8% alpha over the IPO price which is about 2.8% over the usual 5% load for closed-end fund IPO.

    Our perspective on trading and our experience with the results have led us to generally avoid them. However, if nobody buys them on the IPO, then we can't trade them later.

    Shaker: I've seen many people try to explain why a CEF has a discount and I think they all fail. The only thing I've ever seen proven it is that there's the "January effect". What we found is IPOs take that pressure specifically hard during this period. If you get an IPO, you can normally get them at a discount at the end of the year with a typical rebound the following January.

    I know that potentially during the fourth quarter, if a CEF IPO'd at a 5 premium, it might be at a 3-4 discount, maybe even wider. We've never participated in a CEF IPO.

    Galley: Getting back to the buy and hold. It is a risky proposition but we were looking specifically at other funds in that same asset class, other funds by that fund sponsor, where they were trading and compare it to a 5% premium and they are all higher. A reversion closer to those peers is what we are betting on.

    Taggart: Advisors tell me that the most prevalent question they get is, "Is my dividend safe?" Well, we call it distribution rate at Morningstar. I would say most people buy closed-end funds for one of two reasons, one is the discount.

    Secondly, for the income that they generate, closed-end funds typically generate two to three percentage points more in terms of the rate than similar funds in the same category. They do that through a couple of methods that we're going to have to discuss. So, John, closed-end fund, the higher relative income, is it worth the risk?

    Scott: Well, first of all, a closed-end fund is a fixed capital product so the manager never has to worry about redemption pressures like in an open-end bond fund. A closed-end bond fund is an equity that derives its value from bonds. Taxable bond CEFs have a market price volatility about 40% higher than NAV and muni bond CEFs have a market price volatility about 350% higher than NAV volatility (at present). If you are trading, this volatility can be your friend.

    If you look at what the portfolio is yielding, taking out the discounted or premium, and leverage - you can get a sense of what is has to occur in the fund to meet the distribution payment. If the manager needs to pay $0.10 per month, and that came to a 6.2% leverage adjusted net asset value yield - is it reasonable for the sector? What do peer funds show as comparison?

    Galley: Closed-end fund investors, for whatever reason, some funds sell off 10 to 15% just because of a dividend cut. That shows you the irrationality of the investors, but it also shows you on why investors owned that closed-end fund. It was because of the yield and only the yield. They're completely yield focused and again, it goes back to being total return focused. You have to look at everything involved.

    As a board member of that fund, you have to ask yourself, if I cut that dividend, this premium is probably going to evaporate and that loss could be catastrophic to investors. What's the bigger evil? Cut the dividend or just pay out return in capital. Sometimes, I think a board of a closed-end funds in a conundrum and that's why you do see return of capital and sometimes these premiums go higher and higher.

    Taggart: Our studies internally show that of all the distributions made by all closed-end funds last year, 23% were comprised of return of capital and that could be what we consider to be constructive return of capital or destructive return of capital. Destructive is when you're getting your own money back.

    Galley: I'm going to jump in. I don't view the return of capital as necessarily destructive. Unless you're maybe trading at a premium to your net asset value, and you're getting your money back at net asset value, that's not necessarily good. If you're trading at a discount and you're getting your money back, return of capital and it's at a discount, you're getting your money back at net asset value. To me, that's excess return no matter if the fund is losing assets.

    Scott: When people talk about current funds at premiums that have never cut their dividend, I'd say, "Yeah, they've never cut their dividend till the day they announced it in the press release." If you're going to be in those funds, it might be worthwhile to have a stop point that you can live with that's enough below the normal trading volatility of that fund but protective of the premium completely going away.

    Taggart: For us at Morningstar, fund family transparency, education around closed-end funds is very important. I believe that advisers, when they buy a fund they should be able to find that information without having to call the wholesaler on the fund.

    Shaker: We haven't met a fund family that we've decided is too sketchy or too out of touch that we put them on any type of blacklist. In fact, we found in general, surprisingly … you can call these people. They have phone numbers and if you see something strange in annual report you can give them a call and say "What happened?" and they will often tell you.

    Galley: Closed-end funds are 1940 Act registered investment companies, so they are like mutual funds from a reporting standpoint, they have to report at least on a quarterly basis their holdings. You do get that transparency at a minimum. We have analysts that are able to go through the quarterly reports and analyze what their holding, have they had any shifts, etcetera?

    From our standpoint, we think most closed-end funds sponsors are giving us good transparency. They are posting more information on their website, sometimes monthly, sometimes even weekly, daily. We think we're getting quite a bit of transparency as far as being able to assess what's going on in the underlying portfolios and be able to tactically manage our exposure.

    Scott: We find that many funds are very good. The only thing we often wish for is fresher data. When the funds give us fact sheets monthly with updated figures for the balance sheet, for different items, exposure, for state, for bond funds exposure, for duration, we love it because then we have a more recent window into where the fund could go. Sometimes the smaller funds, that only do a quarterly year, or sometimes only do report semiannually lead us to have stale data and we only will buy the fund at that point from a trading perspective not because we're comfortable with the dividend or past holdings.

    Taggart: Why are there discounts and why are there premiums at all in closed-end fund?

    Galley: There has been a lot of academia, research reports, white papers on why discounts? We live in an efficient market, correct? You have a security that's owned by retail investors. They buy and sell for irrational reasons a lot of times, but I will say it's the structure of the closed-end fund that's inefficient. It's not necessarily the investors.

    Scott: To follow up on liquidity, about half of closed-end funds trade between $500K and $2.5M a day in average liquidity and that is not a lot of liquidity. The funds above that level ($2.5M+) are less inefficient, the fund is below that level (under $250K) - I don't know if any of us can regularly buy that unless we're an activist oriented approach with a long time line to get in or out if needed.

    Galley: Today, you have different types of leverage, but really, the margin facility by brokerage firms or banks is probably one of the most prevalent out there and that gives them a lot of flexibility. What they don't have is the benefit of a lock up, meaning that they're typically 365 days of rolling credit. The bank has the ability to pull that leverage from them, but the reality is that very rarely happens. We find that to be pretty cost efficient leverage for the closed-end funds and pretty secure.

    If that leverage went away, probably the dividend is going to get cut and investors are going to sell and it's going to go to a big discount, that's something we're waiting for to try to jump on that opportunity.

    Taggart: One last sentence, advice to advisers and individual investors, where they're looking at close-end funds.

    Scott: Stick to your plan. Track what you're doing. Tweak it over time. Hold the course.

    Galley: Be total return-minded and opportunistic. Don't be all in closed-end funds all the time. Have dry powder to be able to buy more when everybody is going to the exits.

    Shaker: Remember that part of your total return is the growth of the fund, plus or minus the discount capture or discount loss you take. Be mindful, discount matters. Make sure that you're at least following the news on the funds you have, because it can come off with something of a dividend cut, or some good news like manage distribution policy.

    Taggart: Gentlemen, thank you very much for joining us today. Everybody thanks for joining us. Thank you.

    Jun 27 9:34 AM | Link | Comment!
  • Closed-End Fund Activism Panel Summary And How To Identify Opportunities

    It was my pleasure to moderate the "Closed-End Fund Activism" panel January 22 in New York at the 4th Annual Activist Investment conference. The panelists were Andrew Dakos from Bulldog Investors and Art Lipson of Western Investment, both very well known in the world of closed-end fund activism. We were joined by Warren Antler, from AST Fund Solutions as Art was running late and we welcomed his addition as an expert in CEF activism from the proxy solicitation perspective.

    Closed-end fund activism is similar to regular corporate activism except it is typically focused solely on both the short and long-term ways to close a significant discount to net asset value (NYSE:NAV). This is usually done through tender offers, share buy-backs, management changes, adding or removing members of the board of directors, open-ending, or liquidation of the fund at NAV. The goal of the activist investor is to make the extra alpha gained from the narrowing of the discount or shares tendered close to NAV. More information about the conference can be found:

    Our Panelists:

    Andrew Dakos joined Bulldog in 1999 and co-manages the firm's investment strategy. He has serves as a director for The Mexico Equity & Income Fund. He serves as a Principal of Brooklyn Capital Management, a Registered Investment Adviser and is President of Special Opportunities Fund (NYSE:SPE).

    Art Lipson is the Managing Director of Western Investments. He managed the fixed-income research departments at various Wall Street firms. He created the Lehman Brothers Bond indicies in 1973 and retired from Wall Street in 1985.

    Warren Antler is Vice President, CEF Specialist at AST Fund Solutions. He has distributed a monthly dissident tracking and corporate action report on CEFs since 2003.

    JCS: Good afternoon. I have some prepared questions. We also have planned plenty of time for your questions. Do you want to start Warren?

    Warren Antler: In 2012 we've had a record amount of fund merges. A lot of those merges were encouraged by activists getting in the fund, and volunteering to merge into a similar fund, a pretty cool idea. Other than that, the discounts are shrinking. Andy and Art are having a hard time finding targets.

    Andy Dakos: We advise several private partnerships. My partners, Phil Goldstein and Steve Samuels, founded what ultimately became Bulldog Investors about 20 years ago. The objective of our firm is to identify mispriced assets, under-valued sectors. We're typically looking for a security trading at a discount to intrinsic value, and then being active in trying to eliminate or at least narrow that discount. We ran about 40 campaigns over the last 15 years. The majority of those were in closed-end funds.

    JCS: I'd like to start with a question about closed-end funds being well known for yield and discounts. Is there a discount or distribution yield, range that you search for when deciding how easy it will be to use your activist strategies on closed-end funds?

    Andy Dakos: There's certainly a discount level that we look at and where we start to get interested. That's not always an absolute number; it's in the context of other things, asset class, size of the fund, liquidity of the fund. Probably most important, other than the discount itself, is the shareholder base, who else owns the fund. To the extent that obviously the institutional shareholders may hold a large position in a particular closed-end fund. They're more likely to vote for somebody that's coming in and looking to see a narrowing discount vs. the typical individual investor.

    There's only a couple of lead activists in closed-end funds. There are a number of, I'll call them, passive investors or activist followers. Plus with rates so low, investors are reaching for yield in the CEF space. I don't know when, but I believe something will happen; municipal rates falling or a credit crisis relapse. Something is going to happen in the market that will lead to selling and wider discounts, certainly premiums will go away.

    As for the distribution rate, we're not interested in what the distribution components will be, whether it's ordinary income, return of capital, or some combination. That's not what drives our thesis, in terms of investing and building a position in closed-end funds. It's really just about the discount.

    Art Lipson: With CEFs bond funds, you can create a higher yield in the fixed-income fund than you can get in a regular open-end mutual fund. It's not so obvious that you're going to get better performance from an equity fund that's closed-end than an open-end equity fund because of leverage, just more volatility. Most of the opportunities come from the equity fund area where we are often looking at funds with a lower average payout rate.

    JCS: And this has come up since Friday (Jan 18), but Alpine has two funds (NYSE:AOD)/(NYSE:AGD), that cut their dividends by 50%; one that was trading previously at about a 10% premium and one at a mild discount. It's been a pretty rough day for the funds this morning. When funds cut their dividend's dramatically is this a situation where an activist investor would look into buying shares? has an intra-day discount around 16% presently.

    Art Lipson: Western reached an agreement with Alpine a year ago, not to attack any of their funds and to always vote with the board. So, we would not be involved in such a situation, but I could imagine other activists would be consider the fund at those discount levels.

    JCS: So anybody in the room interested? It may be worth looking at today or tomorrow.

    Andy Dakos: In the situation where you have a discount outlier, whatever is causing the outside discount. A discount that wide sticks out like a sore thumb.

    JCS: Let's shift to some of your own activist experiences. Could you share with the group a Board war story?

    Art Lipson: It is our belief that if a fund trades at deep discount to NAV it is a supply and demand issue. Too much supply leads to inadequate demand and wider discounts.

    I'll contrast the situation, first talking about how one board did a good job, and then I'll get into how one did a bad job. With Alpine we arranged a tender for 20% of their shares at 5% discount to NAV. We were a very large holder, as was Bulldog. We signed an agreement with Alpine without filing a 13D notice. We let them know that if they reduced the discount on this fund, we won't be involved with any of your other funds. So that was a case of management acting productively before it came to a proxy situation.

    But last year, we were also involved in a situation on the other side, and this was a fund that was run by Guggenheim. It was a fund half tax-exempt and half equities. They have a staggered board plus have a majority requirement that 50% of all shareholders would have to vote to replace directors. In 2011, we got more votes than their director; however, we didn't get 51% of all votes, so their director was held over. They just steadfastly refused to negotiate and reach any reasonable resolution terms. The first contest was in July in 2011, and the second contest should have been a year later in 2012. They didn't have a contest at all in 2012. The fund went from approximately $300 million in assets to $80 million in assets because they wouldn't work with activists. I think it was arrogance on their part. . That's a 75% drop in assets and revenue because they refused to negotiate. We waited out the fund, showing fund managements that we will stick out hard fights. It shows that if a fund doesn't want to negotiate, they can basically be put out of business.

    Andy Dakos: I'm just going to give one example of what did not work, and then I'll give you an example of what I think is good. We haven't run a proxy contest that went to a meeting since summer of 2009. We were in the midst of a proxy contest with a municipal bond fund. We had built our position at a high teen discount previously. We gave notice to the fund and the board said the notice was not proper. Ultimately, we didn't run the contest that year. It was not a staggered board; the whole board was up for vote. During that time, there certainly could have been an opportunity to sell and close out our position.

    We determined at that time to continue to pursue a proxy contest, to get control of the board. Although we lost a lot of votes at that meeting, we did prevail. We ended up taking over the board. We conducted a large tender offer that took out all the shareholders that participated at 99.5% of NAV. The shareholders then approved a change in the mandate of the fund. After the tender offer the fund shrank from $290 million in assets, down to about $92 or $94 million. I think that from the big picture standpoint, I think that was a seminal event for us. It really showed us what we may be able to accomplish. We haven't had to run a proxy contest since then, I don't think that is a coincidence. We can generate some return for our investors, the fund can go on. Here is an example on how you can lose the entire fund. This has increased our credibility for what we can accomplish in future contests.

    JCS: How do you see the retail shareholders of the funds, as long - term shareholders, benefiting from liquidation? Also, a lot of people say that the activists benefit more than the retail investor, what is your reply to this?

    Art Lipson: We are always looked at with suspicion because we are a hedge fund; we have that label. Opportunists or hedge funds, those are terms that describe the investment style, but it has nothing to do with ethics or fairness to all shareholders. We go into every fund contest and make a statement that we intend to offer the same results to every single shareholder as we get at Western. We have done this in every case, so a shareholder can expect to get the same result, and we are not taking any special fees; we've never taken green mail or anything like that. In terms of the outcome, sometimes, like with an open-ending, it's obvious that everybody gets the same result, but other times it will be resolved through a tender and shareholders there have the choice of whether or not they want to participate in the tender or not and we don't get any special larger allotment than they do. For us it's about fairness because we know we are going to be in future contests down the road and we want to have credibility with moms and pops. We don't want to give ammunition to those proxy solicitors who would use it against us if they could in a contest.

    JCS: My feedback would be that, the average owner of a closed-end fund doesn't watch them, or change their decisions actively so they may not even notice that a tender offer popped up and then say "oh I wish I had gotten part of that" too late. Part of the problem is that in my opinion, too many closed-end fund investors don't monitor their holdings, or they feel like they are going to own a fund forever.

    Andy Dakos: Well, I would say, if you own the stock, it seems to me like you should pay attention, but I can understand where you are coming from. Just answering some of your questions, all shareholders large and small will benefit in that they are going to capture the discount. They may want the [investment] exposure going forward, but I can't think of a case for that asset class where there hasn't been a vehicle for a shareholder to reinvest those proceeds, sometimes at a discount.

    There are plenty open-end funds out there, certainly closed-end funds, that can be invested in at a discount, so I don't think retail shareholders are harmed at all by liquidation, in fact I think it's a benefit.

    JCS: I have one final question before we open it up to the floor. Why isn't there more closed-end fund activism? I mean, on a simple level, you find something trading cheap, you buy enough to cause a change, and you capture the difference of making it "less cheap". Is there a reason why you don't see more competitors on the landscape doing the business that each of you conduct?

    Art Lipson: That's an interesting question. I think the return profile is fairly modest. When you think of activism, sometimes you think of getting an operating company to change its business plan and move up fifty percent, whereas, we are often looking at five or ten or fifteen percent total profit. Those that are well known as activists are looking for much higher return possibility; some of these players are billion dollar players and there just isn't enough dollars in the closed-end fund situation to attract them. I think it's a lower return, but it's a more assured return as a CEF activist.

    Andy Dakos: Just like any activist, whether it's within the closed-end funds space, or in large-cap operating companies, small-cap companies, it's a rather simple business model. But it's difficult to execute, it's not without risk and there is always the potential for litigation that could drive up costs. The closed-end fund sector is just a very small sector of the overall set of publicly traded securities. So I think again, it's what Art said, in terms of return profile plus the risks and costs associated with it.

    JCS: With that I would like to get some questions from the audience, hopefully there's some good ones.

    Audience Question: How important is it for you to analyze the investment holding of a CEF when making an activist play?

    Art Lipson: Well, we are trying to fully hedge all the time and there are some funds that engage in strategies that make it very difficult to hedge. We might find those less attractive as activist candidates. Some of these funds have very high turnover like the Alpine funds that just cut their dividends. They have a dividend capture policy, which I don't believe works in the market, I think it produces negative returns. What it means is they buy a stock, hold it up to, close to, the x-date and then when the whole world knows it's going to pay its dividend, they try and sell it into demand and then buy some more stock farther away from its x-date. They are not successful at this strategy, they have continuing NAV loses and for us to take an activist position in what we think is an under-performing strategy, we could lose more in percentage profits than we gain by the boost at the end. It's hard to believe it but there are funds that do have some bad policies and occasionally you do get the fund with management whose securities selection is terrible and there a number of funds that manage to go out of business all by themselves without any help from Bulldog or us, especially ones that invest in say mortgage - backed securities or leveraged fixed income.

    Andy Dakos: We certainly have a handle on what the funds do and what the exposures are. But, that's really more about diversifying our whole portfolio. We do hedge from time to time but that's really only when we have outsized exposure in any one area, for example in a particular emerging market. We see a cheap asset, if we are able to generate alpha from discount narrowing and if you do that year - in and year -out, the returns, certainly in the intermediate to long-term should be good, certainly against the benchmark.

    Audience Question: Under the Investment Company Act, section 12B, it limits your ability to accumulate shares in these closed-end funds with a 3% cap. Does 12B limit your ability to engage in activism by limiting your ability to accumulate?

    Andy Dakos: No. It's really for the reason that you point out, managing a number of different entities, so it has not impacted us.

    Art Lipson: Same here, it has not been a problem. Of course, we have had excellent counsel in terms of setting up the structure of our business. In doing that, with a number of separate entities, 12B is not that restrictive at all.

    JCS: Any further questions? No. Alright this one is for Bulldog because of Special Opportunities Fund . How do you balance the fiduciary duty to your clients as an investment firm and then to the shareholders of the closed-end fund that you are involved with in a board capacity?

    Andy Dakos: Whenever a principal of Bulldog is on the board, we basically are not involved in any of the decisions with regard to that position that is held by the entity that we advise. The decisions are made by another portfolio manager and there is a Chinese wall set-up.

    It's a big decision for us, more so today than ever I think, in terms of whether or not it makes sense for us, as opposed to other nominees that we might recommend to sit on a board, whether it's a closed-end fund or an operating company, as it's certainly a big time commitment. It's important to keep your question in mind John.

    Art Lipson: The closed-end fund market in my mind continues to be irrational. We can look at that SPE fund that Bulldog took over and I'm for example a shareholder in my IRA and my regular funds. You have a situation where you have a management company that has a clearly above average record, I happen to know the principals directly and know how intelligent they are, but the record reflects that, and yet it's available at a discount. This is also a question of why a discount would exist in a fund entity that has a 15 year proven track record of performance; it seems silly to me. I recommend that stock to pretty much anybody and their grandmothers and grandchildren.

    JCS: We just have 30 seconds left. I'll just recap that from the closed-end fund space in the last 10 years we have averaged about 8 to 9 deaths in the sector per year, we average about 11 mergers during per year, we have averaged 28 IPOs per year. Last year that there were 57 mergers, primarily a lot of small muni bond funds at the state level going from 3 or 2 funds per sponsor to one.

    With that, I know I'm sticking around, the panelists will be around, and come up to any of us to ask some more questions. Thank you both for your insight to the world of CEF activism and DealFlow Media for putting on this conference. It was my pleasure to serve as your moderator. More information about the conference can be found:


    Feb 02 3:09 PM | Link | Comment!
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