The Bulldogs Of Closed-End Fund Investing
Last week, I had a chance to spend some time chatting with Rajeev Das, Head Trader and a principal at Bulldog Investors. Bulldog is one of the leading firms in the fascinating and potentially lucrative closed-end fund activism business. I have long been a fan of buying discounted closed-end funds and have used activist coat tailing in community banks to make a ton of money over the years, so the combination is irresistible to me.
Mr. Das has been with Bulldog since the beginning of the fund and told me they have engaged in about 40 proxy fights over that time, mostly with closed-end funds. While he didn't have the exact percentage at his fingertips when we spoke, most of those campaigns have either been won by Bulldog with board representation or have ended in favorable settlements and outcomes. Today, they are often able to avoid a proxy fight because the management of the target fund is all too well aware that Bulldog will wage a fight with a high probability of success so they negotiate earlier to avoid an expensive proxy fight.
Mr. Das said the firm was attracted to the close end space because of transparency and ease of determining undervaluation. They can see each today, where the funds price traded and exactly what the Net Asset Value of the shares are worth at the end of every day. You know exactly what the discount is and what you can potentially earn if the discount closes.
The strategy of buying closed end funds at a discount has been around as long as closed-end funds have existed. In the good old days, investors would buy the fund and just wait for the discount to eventually narrow in times of market exuberance. While it provided decent returns over time, the problem was that for many funds the discount simply never went away. You might buy a fund at a 15 percent discount to NAV and several years later the shares traded at the same discount. Mr. Das said taking an activist approach gives them more control of their investments and they can force the discount to move closer to the actual asset value much quicker.
The firms approach is very much discount driven.
They want to buy funds where the discount is wide enough that they can accumulate a large position with high enough returns to create alpha over the asset class. The firm has to be comfortable with the assets and valuation of the assets of a fund before they get involved. This has helped them avoid some funds where the discounts are large, but the assets where relatively large and pricing may have been less than reliable. They take a look at the shareholder base to make sure than the current larger shareholders would be likely to vote with Bulldog if it does come down to a proxy fight. Buying a heavily discounted fund with large insider ownership and a group of shareholders friendly to the current management would be an uphill battle at best. They also carefully review corporate governance documents to make sure they do not include any provisions that would make it difficult to nominate directors or push for passage of shareholder proposals.
They then talk to fund management about ways to narrow the discount. Funds can buy back shares to attempt to close then gap to NAV or perhaps conduct a tender offer. Sometimes funds can close the discount by implementing a manage distribution policy that pays out a regular fixed payment to shareholder every month. This is often attractive to yield-seeking individual investors and can bring buying into the shares bring prices closer to net asset values. Although they may resist at first because all of the moves can reduce assets under management and thereby lower fees, the longer management waits the worse the result can be for them. The longer discussion go on, the higher than chances of an expensive proxy fight and the higher the chances that other institutional investors align with Bulldog and management faces chance of being outright replaced.
Bulldog does not have a preferred asset class for the closed-end funds they target. A look at their current holdings shows that they own equity funds, tax free and taxable income funds, real estate funds and even commodity based closed-end funds. They do not make macro calls in their fund selection and base their investing decisions on how much they can make by quickly narrowing the discount to net asset value. Their goal is to earn positive alpha over the funds asset class over the period that they own the shares.
The Alpha over Asset Class approach is also used in the Special Purpose Acquisition Company, or SPAC, investing. SPACs also known as blank check companies, are investment vehicles that raised money and the managers then have to two years to do a deal that shareholders approve of or return the cash. The IPO of a SPAC usually consists of shares and warrants. Cash was held in trust until a deal was announced.
2007 was my last year as a stock broker and the markets were crazy overvalued as the year started and I kept my bills paid by doing SPAC Arbitrage. We would buy the SPAC IPO and then sell the warrants as soon as they were freely traded. Then we would wait for a deal to be announced, vote against it and be given back our share of the trust creating an 8-10 percent annualized return most of the time.
Today, the rules have changed and Mr. Das and Bulldog play the SPAC game a little differently. He recently explained the way they approach SPAC investing in an interview with NYU Sterne School of Business eValuation magazine. He told eValuation:
"Now, if a SPAC announces a deal that you don't like, you can get out. For example, the SPAC will issue $200 million of shares at $10 a share, giving investors one share and one warrant. The money from the IPO will go into the trust, which will be used to fund the deal. When the deal is announced, you have two options. You can continue to stay in the new company or you can get your $10 back. Meanwhile, you also have that warrant which you can sell. If it's a bad deal, the warrants will be worthless, and you can get your $10 back. If it's a good deal, the shares will trade above the trust value and the warrant will pop. And you can make 10-15% on your deal. So, really you have no downside in this investment. SPACs put their money into US treasuries and you can easily get mid-to-high single digit IRRs."
That is substantial Alpha over short-term treasury rates today.
I asked Mr. Das if he thought that the discounted closed-end fund was appropriate of most individual investors. He thought it was and in fact made a great deal of sense. Just buying the asset at a discount should improve returns over a particular asset class, be it stocks or bonds, as the discount narrowed over time. He agreed with me that investors might do even better by buying as soon as the initial 13D was filed revealing a new activist stake taken by Bulldog. You can also track their 13F filing each quarter to see buying and selling of closed-end funds by Bulldog Investors and clone picks where they have not yet taken an activist stance.
There is one other way for individual investors to take advantage of the specialized skill of Rajeev Das and the rest of the team at Bulldog Investing. Back in 2009, Bulldog ended up replacing the Board of the the Insured Municipal Income Fund and replacing it wither own team. They changed the name of the fund to Special Opportunities Fund (SPE) and have managed it using their value activist approach. While it is not a clone of their main hedge fund, it does hold many of the same positions. While they cannot control the market price of their fund Bulldog has been very aggressive about buying back shares when they trade at a discount to NAV.
In their recent shareholder letter they pointed out that:
"As of February 26, 2016, the Fund's discount stood at 14.64%. At that level, it is hard to find a better investment than repurchasing our own shares because it has a meaningful accretive effect on NAV. Consequently, we have recently picked up the pace of our share repurchases. From January 1, 2015 through January 31, 2016, 472,944 shares have been re-purchased, all at a discount of at least 12%."
In January. Bulldog repurchased an additional 67,929 shares and flowed it up with a buy back of 110,421 in February. This is a collection of discounted assets that is itself trading at additional discount and is probably worth considering for long-term patient investors who want to reap the rewards of Bulldogs Closed-end Fund and activist strategies over time.
Investing in closed-end funds at a discount has been part of the value investors playbook for a long time. Mr. Das and his associated at Bulldog have added a new page to the book by adding activist strategies to closed-end fund investing.
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