he man who harpooned the London whale is spearfishing in another obscure area of the financial markets — and now he is inviting ordinaryinvestorstojoinhiminthesport.
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 formostofthepastthreeyears.Ishelaunchingtoolate?
YoumayrememberthatMrWeinsteinmadeabigsplash in 2012 when he took the other side of outsized derivatives trades placed by JPMorgan 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,aswellasnettingMrWeinsteinatidyreturn.
Closed-end funds are small fish by comparison, rarely more than $500m in market cap, but there is a reason they caught Mr Weinstein’s attention. Their shares are so illiquid, they can often trade at very large discounts to the valueoftheunderlyingassets,whichinmanycasesarejust the sort of high-yield bonds, loans and other securities that MrWeinsteinknowswell.
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 partly responsibleforthenarrowingoftheaveragediscountinthesector.
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 per cent of the shares at close to net asset value in a tenderofferthathelpednarrowthediscountto6percent.
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 valuehasshrunkfrom18percentto10percent.
Mr Weinstein was early to the CEF market, suffering as discounts continued to widen in 2015, but last year was a muchstrongeryear,andthelaunchofanactivelymanaged 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 shareholdersmaydriftaway,depressingshareprices.
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 moredovishthananticipated.
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 nowwildlyoutofwhackwithhistoricalaverages.
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 onnoticethattheymustworktoimproveshareprices.
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 pressureonthemtotakeshareholder-friendlyaction.
That will require the skill of a patient fisherman. Making moneyinCEFsisnolongerlikeshootingfishinabarrel.
Activism has rekindled interest and put managers on notice