Tender Offers, Lawsuits, and Mergers: The Rising Tide of CEF Activism

But what if the deal was too good or lasted too long?

It may attract the attention of activist investors. By reducing the discount via a variety of means, activist investors hope to make some quick profits. For shareholders, this could be viewed in a variety of ways. With activism of CEFs rising, investors need to be prepared.

Supply and demand. It’s what makes CEFs’ share prices tick. As we’ve said before, the ‘closed’ in closed-end funds comes from the fact that CEFs launch via an IPO. Unlike a mutual fund or ETF, this causes a CEF to have a fixed number of shares.

For managers of the CEF, this is wonderful as it allows them to be fully invested, own illiquid asset classes, and generally ignore investor redemptions. Mutual fund managers always have a layer of cash to manage inflows and outflows from a fund.

For CEF investors, buying and selling takes place on the major market exchanges. But where an ETF can use creation/redemption of authorized participants to manage investor demand of inflows/outflows, CEF share prices move simply at the whims of supply and demand.

This creates a phenomenon that allows a CEF’s share price to deviate from its underlying value. This can create premiums or discounts. For example, if a CEF is trading at a 15% discount to its net asset value (NAV), you effectively get a dollar’s worth of assets for 85 cents. If it’s trading at a 5% premium, then you are paying $1.05 for a dollar’s worth of assets.

For many investors, buying CEFs at discounts is what makes the asset class special and a good value.

The ultimate hope is that discounts narrow and approach the underlying real value of the fund. Enough investors will boost demand, and therefore the CEF’s share price. Shareholders can then realize some capital gains alongside their hefty distributions.

The problem is many CEFs trade at perpetual discounts to their NAVs, never coming close to matching share prices and NAVs. And sometimes those discounts to NAV can be very large indeed.

That’s where activist investors come in.

Just like when an activist investor targets a CEF, the idea is to narrow the discount. Remember, the fund is actually worth the NAV, not the share price. By narrowing the discount, activists and shareholders can profit.

This can be done in a few ways. After building a large enough stake in a CEF, activists have a few tools to push for change. They can submit proxy proposals to convert the CEF to become an open-ended mutual fund. This instantly causes the share price to trade at NAV, closing the discount. They can also suggest stock buybacks or tender offers.

In a tender offer, an activist will push the CEF to purchase some or all of shareholders’ shares in the fund, often at a premium to the market price. When it comes to CEFs, tender offers are often based on NAVs. So, if a CEF’s share price is trading at a 10% discount to NAV and the fund offers a tender at a 2% discount to NAV, shareholders selling would see an instant 8% profit. Activists can also push for CEF mergers and flat out sue fund sponsors, as was the case between Saba Capital Management and 16 different BlackRock CEFs.

The ultimate idea behind activism is to narrow the discount on the funds and bring share prices and NAVs in-line with each other. Activist investors claim this is beneficial for all investors in a CEF.

It should be noted that three hedge funds— Saba, Karpus Investment Management, and Bulldog Investors —are responsible for the vast bulk of all activist activity within the CEF space. The trio owns shares in more than half of all CEFs and contributed more than 75% of all 13D filings for proxy and other actions last year.

To their credit, the trio has done some good. Several targeted funds have started shareholder buyback plans to reduce discounts and keep the gap between NA and share prices tight, while others have merged and started managed distribution plans to benefit shareholders. There have also been several successful tender offers. The results have fared from good to flat, with returns and the narrowing of NAV/share prices varying. In some cases, it may be too early to know the long-term effects on the funds.

Pundits will argue these activists are in it for the short term. This infographic from the ICI shows activists typically sell their shares in a CEF within a year of making changes, with the bulk (48%) leaving within three months.

Source: ICI

Moreover, the ICI and several other pundits have argued that because of rising activist actions, the sheer number of new CEFs has dropped considerably. In fact, there were no new CEFs launched in 2023 and only three traditional CEFs IPO’d last year. More CEFs are being launched as term trusts or those with a finite end date. This makes it harder to justify activist action and NAVs tend to stay closer to share price. However, they have end dates. ¹²

Overall, activism in the CEF space is growing. Strong distributions and long-term gains are the hallmarks of using CEFs for a portfolio. For investors, they need to do their homework and decide if they want to follow an activist’s plans for a fund they own. Just blindly accepting a proposal or tender offer may not be the best decision depending on why you invested in a CEF in the first place.

Thanks to discounts to NAV, CEFs have increasingly been targeted by activist investors seeking to close the discount and boost share prices. However, that could be short-term thinking. NAVs are necessarily the only thing that matters within the sector. At the end of the day, investors need to evaluate these proposals for themselves and their goals.

¹ ICI (May 2024). Closed-End Fund Activism

² ICI (May 2024). Closed-End Fund Activism Surges, Shows Need for Congressional Action