Activist hedge funds are increasingly targeting closed-end funds (CEFs) to advance their own profits, at the expense of retirees and retail investors. These acquirers threaten to undermine the entire CEF asset class, which is crucial to many retail investor portfolios and the capital markets as a whole.
In recent years, activists have exploited loopholes in Section 12 of the Investment Company Act to buy large stakes in closed-end funds. This tactic has caused the number of closed-end funds to fall from 495 in 2018 to 402 in 2023.
Notably, three major firms – Saba Capital Management, Bulldog Investors and Karpus Management – accounted for more than 80% of the surge in hostile activism.
Saba Capital Management (“Saba”) has positioned its actions as promoting good corporate governance. However, BlackRock’s proxy fight against the 10 CEFs is designed to engineer liquidity events for short-term gain. Such moves could negatively impact long-term investors, particularly retirees and middle-class Americans, who rely on CEFs for stable, fixed income and targeted growth.
The Expanding Investor Opportunity Act, passed by the U.S. House of Representatives with bipartisan support in March, aims to address this issue by closing the loophole and maintaining stability for CEF investors.
CEFs are of great interest to long-term investors because they offer unique advantages over open-end funds. Unlike open-end funds, which continually issue new shares based on their net asset value (NAV), CEFs have a fixed number of shares that trade on the stock exchange throughout the day, like stocks. A fixed supply means that the market price is determined by supply and demand, and is often priced above (a “premium”) or below (a “discount”) the fund’s net asset value. Common types of CEFs include real estate funds and municipal bond funds, but they can also be a combination of stocks and bonds aimed at generating income. These investment vehicles are particularly attractive for pension funds and retirement accounts.
Additionally, CEFs can invest in illiquid assets that are typically inaccessible to the average retail investor, such as private equity and startups. This feature allows CEFs to offer investment opportunities that are typically restricted to high net worth individuals and institutional investors, democratizing access to potentially lucrative markets.
Additionally, most CEFs distribute regular dividends, making them attractive to retirees: CEFs returned $16.7 billion to retail investors in 2022, with about 72% of this income coming from income distributions.
According to data from the Investment Company Institute, the average age of households that own CEFs is 50, the average household income is $100,000, and 39 percent are active retirees, so Saba targets income-generating investments that middle-class Americans and retirees rely on.
Saba has adopted aggressive strategies, including proxy fights, shareholder proposals, director changes and conversion to open-end funds, to seek to profit from the discrepancy between the market price and net asset value of BlackRock’s CEFs. While these actions can temporarily boost the fund’s market price, they generally result in adverse outcomes for most investors.
Specifically, forced liquidations may result in unplanned taxable events, require reinvestment in alternative investments that may have higher fees or are riskier, or disrupt established investment strategies that often deviate from the income generation objectives of funds that are tailored for retirees and long-term individual investors.
As one law firm aptly put it, “The predictable end result here is that closed-end funds that fail to adequately protect themselves will be forced to deliver short-term benefits to activist managers, their allies and their wealthy investors at the expense of long-term retail investors.”
Although Saba had claimed to eliminate the discount to net asset value, its acquisition of two CEFs trading under the tickers BRW and SABA created significant post-acquisition discounts contrary to that assertion.
Saba’s activities are purely to line its own pockets. Targeting the EF space and pitting itself against BlackRock does not serve the interests of retail investors or retirees. Congress should pass the Expanded Investor Opportunity Act to prevent Saba and other acquirers from targeting CEFs.
