We­in­stein waits to reel in the prof­its from closed-end fund move

Financial Times Middle East - - Markets & Investing - Stephen Fo­ley stephen.fo­ley@ft.com

The man who har­pooned the Lon­don whale is spearfish­ing in an­other ob­scure area of the fi­nan­cial mar­kets — and now he is invit­ing or­di­nary in­vestors to join him in the sport.

Boaz We­in­stein, the New York hedge fund man­ager, is plan­ning to launch an ex­change-traded fund that will in­vest in closed-end funds, pub­licly traded US in­vest­ment ve­hi­cles whose shares have looked mis­priced for most of the past three years. Is he launch­ing too late?

You may re­mem­ber that Mr W ein­stein made a big splash in 2012 when he took the other side of out­sized de­riv­a­tives trades placed by JP Mor­gan prop trader Bruno Ik­sil. Those trades were so ill-ad­vis­edly large they earned Mr Ik­sil the nick­name “Lon­don whale” and cost his bank $6bn in losses, as well as net­ting Mr W ein­stein a tidy re­turn.

Closed-end funds are small fish by com­par­i­son, rarely more than $500 min mar­ket cap, but there is ar­eas on they caught Mr We­in­stein’s at­ten­tion. Their shares are so illiq­uid, they can of­ten trade at very large dis­counts to the value of the un­der­ly­ing as­sets, which in many cases are just the sort of high-yield bonds, loans and other se­cu­ri­ties that Mr W ein­stein knows well.

Through his hedge fund Saba Cap­i­tal, he has spent the past cou­ple of years buy­ing up CEF shares and urg­ing their man­agers to nar­row the dis­count. So pro­lific has he be­come, he might rea­son­ably claim to be part­lythe nar­row­ing of the av­er­age dis­count in the sec­tor.

Take the Franklin Limited Du­ra­tion In­come Trust, for ex­am­ple. When Saba took a 14.5 per cent stake in the fund last March, it was trad­ing at an 11 per cent dis­count to its credit port­fo­lio, lead­ing Mr We­in­stein to sug­gest it would be bet­ter wind­ing it­self up and re­turn­ing the money to share­hold­ers. In Jan­uary, the fund’s man­agers agreed to buy back 15 per­cent of the shares at close to net as­set value in a ten­der of­fer that helped nar­row the dis­count to 6 per­cent.

Ac­tion may also be brew­ing at the Clough Global Op­por­tu­ni­ties Fund, which in­vests in both stocks and bonds: Since Saba re­vealed a stake in Jan­uary, a long-time port­fo­lio man­ager has left, and the fund’s dis­count to net as­set value has shrunk from 18 per­cent to 10 per­cent.

Mr We­in­stein was early to the CEF mar­ket, suf­fer­ing as dis­counts con­tin­ued to widen in 2015, but last year was a much stronger year, and the launch of an ac­tively man­aged ETF is an at­tempt to cap­i­talise on his re­cent record. The Saba Closed-End Funds ETF also aims to neu­tralise one of the main ob­jec­tions to in­vest­ing in CEFs, namely that ris­ing in­ter­est rates will be bad for the sec­tor, by adding a rates hedge to the port­fo­lio.

Many CEFs em­ploy lever­age to juice re­turns, so higher rates raise their bor­row­ing costs, at the same time as the bonds in their port­fo­lio may be fall­ing in value. The gen­er­ous monthly div­i­dends that CEFs pay also look rel­a­tively less at­trac­tive in a higher rate en­vi­ron­ment, so share­hold­ers may drift away, de press­ing share prices.

So, ris­ing rates are bad, and that is why the av­er­age dis­count on fixed-in­come CEFs ac­tu­ally nar­rowed sharply last week when the Fed­eral Re­serve’s well-trailed quar­ter­point rise was ac­com­pa­nied by com­men­tary that was more do vish than an­tic­i­pated.

What hap­pens from here? When this col­umn ex­am­ined fixed-in­come CEF shares in Septem­ber 2015, they looked a no-brainer. The dis­count to net as­sets was an av­er­age 11 per cent, worse than at any point in the past decade, out­side the credit cri­sis. At un­der 4 per cent, dis­counts are not now wildly out of whack with his­tor­i­cal av­er­ages.

The rea­son dis­counts have nar­rowed sub­stan­tially in the past 18 months is partly be­cause the Fed has made it clear in­ter­est rate rises will be grad­ual, and partly be­cause ac­tivism has rekin­dled in­ter­est in the sec­tor and put man­agers on no­tice that they must work to im­prove share prices.

There will still be op­por­tu­ni­ties for profit, since funds with weak man­agers or those with par­tic­u­larly unloved in­vest­ment strate­gies can trade at dou­ble-digit dis­counts, and many con­tain pro­vi­sions deep in their prospec­tuses that could be used to trig­ger liq­ui­da­tion or put other pres­sure on them to take share­holder-friendly ac­tion.

That will re­quire the skill of a pa­tient fish­er­man. Mak­ing money in­CEFs is no longer like shoot­ing fish in a bar­rel.

Ac­tivism has rekin­dled in­ter­est and put man­agers on no­tice

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