Closed-End Fund Activism Panel

Shareholders

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.