It was my pleasure to moderate the “Closed-End Fund Activism” panel January 22 in New York at the Fourth Annual Activist Investment conference. The panelists were Andrew Dakos from Bulldog Investors and Art Lipson of Western Investment, both very well known in the world of closed-end fund activism. We were joined by Warren Antler, from AST Fund Solutions as Art was running late and we welcomed his addition as an expert in CEF activism from the proxy solicitation perspective.
Closed-end fund activism is similar to regular corporate activism except it is typically focused solely on both the short and long-term ways to close a significant discount to net asset value (NAV). This is usually done through tender offers, share buy-backs, management changes, adding or removing members of the board of directors, open-ending, or liquidation of the fund at NAV. The goal of the activist investor is to make the extra alpha gained from the narrowing of the discount or shares tendered close to NAV.
Andrew Dakos joined Bulldog in 1999 and co-manages the firm’s investment strategy. He has serves as a director for The Mexico Equity & Income Fund. He serves as a Principal of Brooklyn Capital Management, a Registered Investment Adviser and is President of Special Opportunities Fund (SPE).
Art Lipson is the Managing Director of Western Investments. He managed the fixed-income research departments at various Wall Street firms. He created the Lehman Brothers Bond indicies in 1973 and retired from Wall Street in 1985.
Warren Antler is Vice President, CEF Specialist at AST Fund Solutions. He has distributed a monthly dissident tracking and corporate action report on CEFs since 2003.
JCS: Good afternoon. I have some prepared questions. We also have planned plenty of time for your questions. Do you want to start Warren?
Warren Antler: In 2012 we've had a record amount of fund merges. A lot of those merges were encouraged by activists getting in the fund, and volunteering to merge into a similar fund, a pretty cool idea. Other than that, the discounts are shrinking. Andy and Art are having a hard time finding targets.
Andy Dakos: We advise several private partnerships. My partners, Phil Goldstein and Steve Samuels, founded what ultimately became Bulldog Investors about 20 years ago. The objective of our firm is to identify mispriced assets, under-valued sectors. We're typically looking for a security trading at a discount to intrinsic value, and then being active in trying to eliminate or at least narrow that discount. We ran about 40 campaigns over the last 15 years. The majority of those were in closed-end funds.
JCS: I'd like to start with a question about closed-end funds being well known for yield and discounts. Is there a discount or distribution yield, range that you search for when deciding how easy it will be to use your activist strategies on closed-end funds?
Andy Dakos: There's certainly a discount level that we look at and where we start to get interested. That's not always an absolute number; it's in the context of other things, asset class, size of the fund, liquidity of the fund. Probably most important, other than the discount itself, is the shareholder base, who else owns the fund. To the extent that obviously the institutional shareholders may hold a large position in a particular closed-end fund. They're more likely to vote for somebody that's coming in and looking to see a narrowing discount vs. the typical individual investor.
There's only a couple of lead activists in closed-end funds. There are a number of, I'll call them, passive investors or activist followers. Plus with rates so low, investors are reaching for yield in the CEF space. I don't know when, but I believe something will happen; municipal rates falling or a credit crisis relapse. Something is going to happen in the market that will lead to selling and wider discounts, certainly premiums will go away.
As for the distribution rate, we're not interested in what the distribution components will be, whether it's ordinary income, return of capital, or some combination. That's not what drives our thesis, in terms of investing and building a position in closed-end funds. It's really just about the discount.
Art Lipson: With CEFs bond funds, you can create a higher yield in the fixed-income fund than you can get in a regular open-end mutual fund. It's not so obvious that you're going to get better performance from an equity fund that's closed-end than an open-end equity fund because of leverage, just more volatility. Most of the opportunities come from the equity fund area where we are often looking at funds with a lower average payout rate.
JCS: And this has come up since Friday (Jan 18), but Alpine has two funds (Tickers: AOD and AGD), that cut their dividends by 50%; one that was trading previously at about a 10% premium and one at a mild discount. It's been a pretty rough day for the funds this morning. When funds cut their dividend’s dramatically is this a situation where an activist investor would look into buying shares? (AOD) has an intra-day discount around 16% presently.
Art Lipson: Western reached an agreement with Alpine a year ago, not to attack any of their funds and to always vote with the board. So, we would not be involved in such a situation, but I could imagine other activists would be consider the fund at those discount levels.
JCS: So anybody in the room interested? It may be worth looking at today or tomorrow.
Andy Dakos: In the situation where you have a discount outlier, whatever is causing the outside discount. A discount that wide sticks out like a sore thumb.
JCS: Let's shift to some of your own activist experiences. Could you share with the group a Board war story?
Art Lipson: It is our belief that if a fund trades at deep discount to NAV it is a supply and demand issue. Too much supply leads to inadequate demand and wider discounts.
I’ll contrast the situation, first talking about how one board did a good job, and then I'll get into how one did a bad job. With Alpine we arranged a tender for 20% of their shares at 5% discount to NAV. We were a very large holder, as was Bulldog. We signed an agreement with Alpine without filing a 13D notice. We let them know that if they reduced the discount on this fund, we won't be involved with any of your other funds. So that was a case of management acting productively before it came to a proxy situation.
But last year, we were also involved in a situation on the other side, and this was a fund that was run by Guggenheim. It was a fund half tax-exempt and half equities. They have a staggered board plus have a majority requirement that 50% of all shareholders would have to vote to replace directors. In 2011, we got more votes than their director; however, we didn’t get 51% of all votes, so their director was held over. They just steadfastly refused to negotiate and reach any reasonable resolution terms. The first contest was in July in 2011, and the second contest should have been a year later in 2012. They didn't have a contest at all in 2012. The fund went from approximately $300 million in assets to $80 million in assets because they wouldn't work with activists. I think it was arrogance on their part. . That's a 75% drop in assets and revenue because they refused to negotiate. We waited out the fund, showing fund managements that we will stick out hard fights. It shows that if a fund doesn’t want to negotiate, they can basically be put out of business.
Andy Dakos: I'm just going to give one example of what did not work, and then I'll give you an example of what I think is good. We haven’t run a proxy contest that went to a meeting since summer of 2009. We were in the midst of a proxy contest with a municipal bond fund. We had built our position at a high teen discount previously. We gave notice to the fund and the board said the notice was not proper. Ultimately, we didn’t run the contest that year. It was not a staggered board; the whole board was up for vote. During that time, there certainly could have been an opportunity to sell and close out our position.
We determined at that time to continue to pursue a proxy contest, to get control of the board. Although we lost a lot of votes at that meeting, we did prevail. We ended up taking over the board. We conducted a large tender offer that took out all the shareholders that participated at 99.5% of NAV. The shareholders then approved a change in the mandate of the fund. After the tender offer the fund shrank from $290 million in assets, down to about $92 or $94 million. I think that from the big picture standpoint, I think that was a seminal event for us. It really showed us what we may be able to accomplish. We haven’t had to run a proxy contest since then, I don’t think that is a coincidence. We can generate some return for our investors, the fund can go on. Here is an example on how you can lose the entire fund. This has increased our credibility for what we can accomplish in future contests.
JCS: How do you see the retail shareholders of the funds, as long – term shareholders, benefiting from liquidation? Also, a lot of people say that the activists benefit more than the retail investor, what is your reply to this?
Art Lipson: We are always looked at with suspicion because we are a hedge fund; we have that label. Opportunists or hedge funds, those are terms that describe the investment style, but it has nothing to do with ethics or fairness to all shareholders. We go into every fund contest and make a statement that we intend to offer the same results to every single shareholder as we get at Western. We have done this in every case, so a shareholder can expect to get the same result, and we are not taking any special fees; we’ve never taken green mail or anything like that. In terms of the outcome, sometimes, like with an open–ending, it’s obvious that everybody gets the same result, but other times it will be resolved through a tender and shareholders there have the choice of whether or not they want to participate in the tender or not and we don’t get any special larger allotment than they do. For us it’s about fairness because we know we are going to be in future contests down the road and we want to have credibility with moms and pops. We don’t want to give ammunition to those proxy solicitors who would use it against us if they could in a contest.
JCS: My feedback would be that, the average owner of a closed–end fund doesn’t watch them, or change their decisions actively so they may not even notice that a tender offer popped up and then say “oh I wish I had gotten part of that” too late. Part of the problem is that in my opinion, too many closed–end fund investors don’t monitor their holdings, or they feel like they are going to own a fund forever.
Andy Dakos: Well, I would say, if you own the stock, it seems to me like you should pay attention, but I can understand where you are coming from. Just answering some of your questions, all shareholders large and small will benefit in that they are going to capture the discount. They may want the [investment] exposure going forward, but I can’t think of a case for that asset class where there hasn’t been a vehicle for a shareholder to reinvest those proceeds, sometimes at a discount.
There are plenty open–end funds out there, certainly closed–end funds, that can be invested in at a discount, so I don’t think retail shareholders are harmed at all by liquidation, in fact I think it’s a benefit.
JCS: I have one final question before we open it up to the floor. Why isn’t there more closed–end fund activism? I mean, on a simple level, you find something trading cheap, you buy enough to cause a change, and you capture the difference of making it “less cheap”. Is there a reason why you don’t see more competitors on the landscape doing the business that each of you conduct?
Art Lipson: That’s an interesting question. I think the return profile is fairly modest. When you think of activism, sometimes you think of getting an operating company to change its business plan and move up fifty percent, whereas, we are often looking at five or ten or fifteen percent total profit. Those that are well known as activists are looking for much higher return possibility; some of these players are billion dollar players and there just isn’t enough dollars in the closed–end fund situation to attract them. I think it’s a lower return, but it’s a more assured return as a CEF activist.
Andy Dakos: Just like any activist, whether it’s within the closed–end funds space, or in large–cap operating companies, small–cap companies, it’s a rather simple business model. But it’s difficult to execute, it’s not without risk and there is always the potential for litigation that could drive up costs. The closed–end fund sector is just a very small sector of the overall set of publically traded securities. So I think again, it’s what Art said, in terms of return profile plus the risks and costs associated with it.
JCS: With that I would like to get some questions from the audience, hopefully there’s some good ones.
Audience Question: How important is it for you to analyze the investment holding of a CEF when making an activist play?
Art Lipson: Well, we are trying to fully hedge all the time and there are some funds that engage in strategies that make it very difficult to hedge. We might find those less attractive as activist candidates. Some of these funds have very high turnover like the Alpine funds that just cut their dividends. They have a dividend capture policy, which I don’t believe works in the market, I think it produces negative returns. What it means is they buy a stock, hold it up to, close to, the x–date and then when the whole world knows it’s going to pay its dividend, they try and sell it into demand and then buy some more stock farther away from its x–date. They are not successful at this strategy, they have continuing NAV loses and for us to take an activist position in what we think is an under–preforming strategy, we could lose more in percentage profits than we gain by the boost at the end. It’s hard to believe it but there are funds that do have some bad policies and occasionally you do get the fund with management whose securities selection is terrible and there a number of funds that manage to go out of business all by themselves without any help from Bulldog or us, especially ones that invest in say mortgage – backed securities or leveraged fixed income.
Andy Dakos: We certainly have a handle on what the funds do and what the exposures are. But, that’s really more about diversifying our whole portfolio. We do hedge from time to time but that’s really only when we have outsized exposure in any one area, for example in a particular emerging market. We see a cheap asset, if we are able to generate alpha from discount narrowing and if you do that year – in and year –out, the returns, certainly in the intermediate to long–term should be good, certainly against the benchmark.
Audience Question: Under the Investment Company Act, section 12B, it limits your ability to accumulate shares in these closed–end funds with a 3% cap. Does 12B limit your ability to engage in activism by limiting your ability to accumulate?
Andy Dakos: No. It’s really for the reason that you point out, managing a number of different entities, so it has not impacted us.
Art Lipson: Same here, it has not been a problem. Of course, we have had excellent counsel in terms of setting up the structure of our business. In doing that, with a number of separate entities, 12B is not that restrictive at all.
JCS: Any further questions? No. Alright this one is for Bulldog because of Special Opportunities Fund (SPE). How do you balance the fiduciary duty to your clients as an investment firm and then to the shareholders of the closed–end fund that you are involved with in a board capacity?
Andy Dakos: Whenever a principal of Bulldog is on the board, we basically are not involved in any of the decisions with regard to that position that is held by the entity that we advise. The decisions are made by another portfolio manager and there is a Chinese wall set–up.
It’s a big decision for us, more so today than ever I think, in terms of whether or not it makes sense for us, as opposed to other nominees that we might recommend to sit on a board, whether it’s a closed-end fund or an operating company, as it’s certainly a big time commitment. It’s important to keep your question in mind John.
Art Lipson: The closed–end fund market in my mind continues to be irrational. We can look at that SPE fund that Bulldog took over and I’m for example a shareholder in my IRA and my regular funds. You have a situation where you have a management company that has a clearly above average record, I happen to know the principals directly and know how intelligent they are, but the record reflects that, and yet it’s available at a discount. This is also a question of why a discount would exist in a fund entity that has a 15 year proven track record of performance; it seems silly to me. I recommend that (SPE) stock to pretty much anybody and their grandmothers and grandchildren.
JCS: We just have 30 seconds left. I’ll just recap that from the closed-end fund space in the last 10 years we have averaged about 8 to 9 deaths in the sector per year, we average about 11 mergers during per year, we have averaged 28 IPOs per year. Last year that there were 57 mergers, primarily a lot of small muni bond funds at the state level going from 3 or 2 funds per sponsor to one.
With that, I know I’m sticking around, the panelists will be around, and come up to any of us to ask some more questions. Thank you both for your insight to the world of CEF activism and DealFlow Media for putting on this conference. It was my pleasure to serve as your moderator. More information about the conference can be found here.