A closed-end fund (CEF) is a type of Registered Investment Company, similar to a mutual fund. Like most mutual funds, these funds hold a portfolio of underlying stocks, bonds, and other securities. However, there are two important distinctions that make these funds unique.
- Traditional mutual funds are priced at net asset value (NAV) after the market close, while CEFs trade throughout the day. In this way, CEFs have daily liquidity and more closely resemble an exchange traded fund (ETF).
- Unlike ETFs, however, CEFs do not have a “creation redemption feature.” Without this feature, the price of a CEF is driven by supply and demand and, therefore, large price gaps can occur between a fund’s trade price and NAV, often referred to a discount (or premium) to NAV. By comparison, large spreads between price and NAV are rare for ETFs.
Every investor is looking for pricing inefficiencies in the marketplace, and we feel that CEFs trading at a discount to their NAV can provide meaningful value within a challenging investment landscape. In this short article, we will discuss how shareholder activity can be a part of this investment strategy.
As a shareholder in an individual company or fund, each share entitles you to a vote. The board of that company is there to serve the shareholders’ best interest, which means as a shareholder, you can encourage the board to take action that can improve the value of your shares. As your ownership stake increases, so too does your ability to encourage specific action from the board.
In the closed-end fund market, there are three main actions that are pursued by activist investors:
- Liquidating (closing) the fund at NAV;
- Making a tender offer to buy back outstanding shares at a premium to the market price, or;
- Forcing a merger or consolidation into a fund that trades at a higher valuation.
All three of these measures can narrow the gap between share price and NAV — and increase individual shareholders’ return on their investment. While RVP is rarely an activist, at times we will establish positions where such pressures exist.
Case Study: GFY Liquidation
Over a number of years, RVP acquired a large position in GFY, a higher-quality, short-duration bond fund as we found the underlying assets and valuation provided an attractive risk return profile. We purchased shares largely between an 8% to 13% discount to NAV. We paid between $0.87-$0.92 for $1 of assets.
Recently, GFY’s parent company, Legg Mason, was purchased by another large asset manager, Franklin Resources. When a change of ownership has been agreed to by the parent company, the shareholders of the funds must approve the ownership change for the fund to be managed by the acquiring company. As a large shareholder of GFY, we voted against the change of control, although this was not our original intent. We believed this was shareholders opportunity to realize the actual assets of the fund. Legg Mason was likely not going to do this proactively. Afterall, Legg Mason was acquired at a meaningful premium, why shouldn’t GFY shareholders get some benefit too?
Following the vote, the fund announced it would liquidate. As a result, shareholders will be able to sell the fund at NAV and, in doing so, realize a gain on the spread between their average purchase price and the NAV. In total, this means that shareholders who purchased their shares at a discount to NAV will be able to realize a return from three areas:
- The underlying asset performance of the holdings;
- The income generated by the assets, and;
- The narrowing of the spread between price and NAV, brought about by the fund liquidation.
In this instance, the change in ownership was the catalyst for the liquidation; however, fund liquidations and other NAV realization events can be driven by investors at any time.
Focusing On Investors’ Best Interests
With interest rates at historic lows, today’s environment can make it difficult for investors to achieve a meaningful return from fixed-oriented investments. At RVP, we are always on the lookout for pricing inefficiencies in the market that we can leverage on behalf of our clients to improve returns. Most importantly, we will always push for measures that are in the best interest of our investors.
If this approach and mindset sound like the right fit for your individual or institutional needs, we invite you to connect with our team.
ABOUT THE AUTHOR: GREG NEER, Partner/Portfolio Manager
A Partner and Portfolio Manager at Relative Value Partners, Greg Neer oversees research and analytics. Day-to-day, he takes an active role in building relationships with fund companies, researching individual holdings, identifying new trade ideas and managing the trading of the strategies. Greg started his career at Stifel Nicolaus, covering the closed-end fund sector as a Senior Equity Analyst. From there, he moved to Bear Stearns/JPMorgan, becoming a Desk Analyst and proprietary trader, also in closed-end funds.
Greg earned his Bachelor of Science in Business Administration from American University’s Kogod School of Business. He also holds a Master of Science from Northwestern University’s McCormick School of Engineering.
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Relative Value Partners, LLC which can only be provided through a formal advisory relationship. Clients of the firm who have specific questions should contact their Relative Value Partners counselor. All other inquiries, including a potential advisory relationship with Relative Value Partners, can be directed here.