Boaz v BlackRock: Whoever wins, closed-end funds lose
Farewell to a financial mystery
But the asset-management giant’s battle with Saba Capital, an activist fund, has cast it in an unfamiliar role: as besieged incumbent.
Ten of BlackRock’s investment vehicles, known as closed-end funds, are in Saba’s sights.
The funds—worth nearly $10bn based on current share prices—run at a steep discount to the value of the assets in their portfolios.
Like publicly listed firms, closed-end funds sell shares in an initial public offering and trade on secondary markets.
Since they do not offer new shares to incoming investors, as mutual and exchange-traded funds do, their share prices are able to drift far from the value of their assets.
Boaz Weinstein, Saba’s founder, wants BlackRock’s funds to offer to buy back shares from investors, pointing to a history of poor returns.
He argues that if investors could exit at the full value of their assets, some $1.4bn in value would be unlocked.
Saba is also promoting a slate of nominees to the funds’ boards at shareholder meetings scheduled across the second half of June.
These representatives will, it says, negotiate for lower fees.
In this sense, the battle is typical of those between activists and their targets.
But in another sense, it represents a bigger struggle.
The markdown that has activist investors licking their lips has long preoccupied some of finance’s best-known researchers.
Closed-end funds, known as investment trusts in Britain, tend to trade at a large discount to their net asset value (nav) over long periods.
At the end of last year closed-end equity funds were 10% cheaper than their underlying assets.
On average they have been 7% cheaper since 1995.
Persistent discounts violate one of the fundamental assumptions of efficient financial markets: the law of one price.
This holds that two identical assets should converge in price, and that long-term differences must reflect intervention or friction.
Behavioural economists, such as Richard Thaler, a Nobel prizewinner, hold that the long-standing nature of closed-end-fund discounts is an argument against the rationality of markets.
As far back as 1949, Benjamin Graham, an author and investor, called the discount “an expensive monument erected to the inertia and stupidity of stockholders”.
BlackRock has pushed back against the activists, arguing that the interests of the funds’ shareholders risk being trampled by people looking for a quick buck, who will harm the funds’ investment strategies.
But whoever wins the battle, closed-end funds seem likely to lose eventually.
They have found themselves under increasing pressure in recent years.
Other specialist activists, including Bulldog Investors and Karpus Investment Management, have deployed Saba-like strategies against a range of closed-end funds.
This year Elliott Investment Management, a larger activist fund, successfully pursued a British investment trust.
Advocates for closed-end funds, including the funds themselves and industry bodies, say that this relentless activism is deterring new fund launches.
Indeed, no new ones were established last year, and their overall number has declined every year over the past decade.
But there are other important factors at play.
In recent years, for instance, higher interest rates have lowered returns on closed-end funds, which often take on leverage to magnify returns.
More straightforwardly, critics are also winning the argument about the value offered by such investment vehicles.
In the early 1950s, just after Graham penned his attack, closed-end funds held assets worth almost 70% of those in mutual funds.
As late as the mid-1970s, the ratio was 25%.
Now closed-end funds are outgunned not just by mutual funds but by exchange-traded ones, too.
Among the three categories, they hold just 1% of total assets.
Even before adjusting for inflation, their assets have not increased in value in 19 years.
Although it has taken longer than half a century, the steady decline in the assets held in such funds indicates that the market has become a little more rational than suggested by Graham’s peppery analysis in the 1940s.
With no sign that the discounts are fading, investors have instead voted with their feet.
Whether Saba or BlackRock ultimately triumphs, closed-end funds and the puzzle concerning them have become a marginal part of finance.
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