If you are a member of one of the nearly 4 million American households who own a long-term investment vehicle called a closed-end fund, you should be paying attention to a battle playing out between investors like yourself, as well as the fund sponsors, against an activist investor seeking a quick profit that would change the nature of your investment—and perhaps the trajectory of your retirement plan.
First, some definitions. Investopedia defines a closed-end fund as “a type of mutual fund that issues a fixed number of shares through one initial public offering to raise capital for its investments. Its shares can then be bought and sold on a stock exchange, but no new shares will be created, and no new money will flow into the fund.” They differ from open-end funds, like the majority of mutual funds and exchange traded funds, where the sponsor regularly issues new shares when investors want to buy them, and also buys shares back when investors want to sell them. The price, established once daily, is based on the value of the underlying assets, known as net asset value (NAV). In contrast, the price of closed-end funds, which trade on stock markets, changes constantly based on the market price, not the NAV. In fact, the price of a closed-end fund almost always sells at either a premium, or a higher amount than the NAV, or at a discount, or less than the NAV.
Neither type of fund is “better” or “worse.” Rather, each offers different pros and cons. For instance, closed-end funds often offer access to investments not otherwise easily available to a regular investor, which provides investors some serious asset-class diversification. Additionally, closed-end funds have the ability to leverage investments in ways that open-ended mutual funds can’t. I like to think of them as a hedge fund for the rest of us.
Certain retirees also include closed-end funds in their portfolio mix because of the fund’s ability to offer long-term capital preservationand reliable income. Open-ended funds, on the other hand, tend to be less volatile and more appropriate for shorter term investments, in part because of their pricing mechanism—which is directly tied to the NAV. And the open-end sponsor’s obligation to buy back shares on investor’s demand offers a sense of liquidity and safety.
The somewhat novel risk now facing long-term investors in closed-end funds is that an activist investor, Saba Capital Management, L.P., is trying to take control of some closed-end funds to take advantage of the funds’ discount from the NAV. This might naturally lead to liquidation of some of the funds’ underlying investments, which is how Saba promises to “unlock value” for investors. Saba says that it “seeks to generate superior absolute returns compared to high yield ETFs and similar instruments.” Indeed. But savvy closed-end fund investors will properly identify this as a bug, not a feature.
Why? Because they didn’t choose to invest in a high-yield ETF. Had they wanted to do so, there are hundreds of high-yield ETF options available. But they instead invested in closed-end funds, presumably because they wanted the benefits of a closed-end fund and were willing to accept this type of vehicle’s inherent risks, such as not keeping pace with the NAV.
Sure, new money entering a fund is never a bad thing, but if it comes with a plan to change the nature of the investment vehicle, that could harm investors. Imagine a retiree seeking stable income getting hit with an unexpected capital gains tax as a result of a Saba-led shakeup.
"Unlocking value" is a polite way of promising to liquidate underlying investments that account for the difference between NAV and the price of the fund. But doing so should be expected to destroy long-term value and undermine the intent not only of the fund sponsor, in this case, BlackRock, but of responsible long-term investors—often retirees who consider the pros and cons of each investment type and choose to own closed-end funds, usually as part of a broad mix of vehicles and different asset classes.
Saba’s activist approach would change the nature of these closed-end funds to have them perform more like open-ended funds. And in their effort to unlock value for their own short-term investment, they may actually sabotage your retirement plan.
Imagine if you went to a restaurant and ordered duck, and someone neither in your party nor your wait staff went into the kitchen and changed your order to turkey, and then boasted that they’d make your duck taste more like turkey.
Fortunately, according to Bloomberg, BlackRock is trying to maintain the integrity of your investment, as well as their control of the funds.
In addition, the Securities and Exchange Committee has begun to level the playing field and enhance transparency by advancing a rule that would require investors like Saba to disclose their investments in a more timely manner, which would help investors and fund sponsors defend against the corporate raid.
But at the end of the day, caveat emptor. Investors should be forewarned about enticing promises by outside interests to “unlock value.” Or in plain English, if you ordered a duck, don’t let anyone turn your investment into a turkey.
