(Bloomberg) -- In an oft-overlooked corner of the finance industry, Boaz Weinstein is waging perhaps his most ambitious battle yet.
Fresh off two legal victories over fund giants BlackRock Inc. and Nuveen, Weinstein — a veteran credit derivatives trader who played a key role in taking down the London Whale — has his sights on upending the $240 billion closed-end fund industry.
At stake is upwards of $17 billion in total potential gains for investors in the funds.
To hear Weinstein tell it, his activism in the closed-end fund industry, which spans the better part of a decade, is rooted in its mismanagement. Too often, fund managers are more interested in collecting fees than maximizing returns for shareholders, who mainly consist of retirees and others seeking steady income. If he succeeds, they’ll benefit too.
“We’re pushing back against grotesque behavior from some in the asset-management industry,” Weinstein, who runs Saba Capital Management, said in an interview. “We’re pushing back on the ones where the manager is acting in a problematic way that without us, there’s no hope for them because the retail investor cannot defend themselves.”
If it sounds something like a crusade for the greater good, his antagonists are having none of it. Many in the closed-end fund industry are fighting him in court and call firms like his “pirates” looking for nothing more than short-term profits at the expense of more patient investors.
What’s not in dispute is just how much money Weinstein has put on the line in recent months. Nearly 70% of Saba’s $5.6 billion in equity assets were in closed-end fund positions as of December, according to data compiled by Bloomberg, more than twice as much in dollar terms as the same period last year.
Weinstein’s fights center around funds that buy income-producing assets, like junk bonds, municipal debt, or dividend-paying stocks, that have been clobbered by the Federal Reserve’s rate-hike campaign. With bond prices plunging across markets, investors have looked to bail out of closed-end funds.
That exodus has pushed down the stock prices for the publicly listed funds to bargain levels, often below the value of the assets they hold, known as the net asset value or NAV. The scale of the discounts is breathtaking: nearly half of the 243 closed-end bond funds in the US trade at a discount of at least 10%, while in March 2022 less than a tenth did, according to John Cole Scott at Closed-End Fund Advisors. Bond funds account for about 60% of the closed-end fund universe, he said.
If activists like Weinstein could erase the discount in every US closed-end fund trading for less than net asset value, investors could earn about $17 billion, according to David Cohne, a mutual fund analyst at Bloomberg Intelligence, who looked at data through Nov. 30.
The discounts arise from the unusual way that the funds are put together. Closed-end funds are designed to be able to buy and hold assets long term. They sell shares in an initial offering, and then invest the proceeds. When one of the original shareholders wants to exit the fund, they must sell to another investor, but the closed-end fund keeps investing the money it originally raised. When too many investors are looking to exit, the shares can trade below the value of the fund’s assets.
That’s different from open-end funds, where an investor who wants to exit redeems their shares with the money manager and gets paid in cash. The fund might raise that money through selling off some of the assets in the underlying portfolio. Weinstein often presses money managers to turn their funds into open-ended funds, exchange-traded funds, or other vehicles where investors can easily cash out and get the full market value of their investment.
“In closed-end fund activism, the medicine of open-ending into a mutual fund or ETF or a tender will collapse the discount every time — and all investors benefit,” Weinstein told Bloomberg.
That pressure might come through electing new directors to the boards that oversee funds. If the closed-end fund resists the pressure, by for example making it harder for Saba to vote in new directors, the hedge fund is willing to sue. A US court in New York this month ruled that 11 funds, some managed by BlackRock, had illegally stripped Saba of votes when they implemented rules limiting how many shares could be used for voting.
An appeals court at the start of December ruled that Nuveen had also illegally blocked Saba’s efforts. A spokesperson for Nuveen said the firm and the trustees for the funds were disappointed with the ruling, saying in a statement that “Nuveen believes that this ruling will harm the interests of long-term shareholders across the broader closed-end fund industry.”
Switching a fund to an open-ended structure often translates to money managers having to sell assets they had expected to hold long-term. The fund’s assets will often shrink further, as will its fee income. Investors who remain can be hurt, according to Kenneth Fang, associate general counsel at the Investment Company Institute, a trade group. He called activist hedge funds “pirates.”
“They are coming in and seizing upon the discounts, looking for liquidity events to get out pretty quickly so that obviously they can earn short-term profits,” Fang said. “But when they do that, they leave a whole bunch of remaining investors in a worse situation — they are left with a fund with less assets and have lost the economies of scale that they had with the larger fund. And, thus, expenses creep up.”
A spokesperson for BlackRock said, “The real victims here are hardworking Americans seeking a secure retirement, not a billion-dollar hedge fund.”
BlackRock’s closed-end funds and their boards of trustees have taken steps to improve shareholder value, including increasing distributions for shareholders and launching funds that offer investors 100% liquidity at net asset value on a future date, the spokesperson said.
Investors should be able to pull money out of funds without having to sell at below net asset value, and shift into other assets, Weinstein said. Closing fund discounts through an activist campaign can take years, and often isn’t just a quick way to get easy returns. And fund managers that disagree are mainly looking to keep up their asset levels so their fee income won’t fall, he said. Investors benefit by getting more ready access to their funds.
“Saba received countless thank-yous from the mom-and-pop investors who spent years in funds stuck at double-digit discounts to NAV,” Weinstein said.
