Closed-end fund Liquidations

Closed-end fund liquidations

Closed-end fund liquidations and similar actions can be a fairly attractive opportunity for most investors. This is where a closed-end fund decides to go out of business and sells all of the securities the company owned and sends the proceeds back to the investor in the fund while also canceling the stock of the fund. Alternatively a way for a closed-end fund to eliminate the discount a fund trades at is to convert the fund from a closed-end fund to an open-end fund or an ETF.

There are currently a few opportunities such as $KEF and $JFC that offer decent returns with low correlation to the U.S. stock market because they both have foreign emphasis. Both funds have announced their intention to liquidate but both funds have to have votes on the matter. $KEF is a Korean focused firm and $JFC is a regional china focused firm with holdings in the mainland, Singapore, Hong Kong and Taiwan. Both of these opportunities can be bought at ~5% discounts to the net asset value of the funds. On an annualized basis the returns from liquidation are 10-30% if the underlying assets remain the same as today.

If there were specific dates as to when the liquidation would occur in either case the discount would probably be in the 2% or less range for a month or less. An investor such as myself would probably not require a giant hurdle rate to invest in liquidations of all types but I think my required rate of return is at a minimum 12-15%. So an investment in a company trading at a 1% discount that requires a 2 month investment is probably not in the cards for me but I can see the interest for different investors.

The major risk is an overall dislocation in the various geographies the funds cover. Is say a 5% correction possible in either market within 2-5 months? The answer is in the affirmative. Many funds will take the additional step to hedge out the underlying assets to eliminate said market swings. I usually do not hedge because it’s expensive and it can cause one a great deal of damage under certain low probability, high hazard scenarios.

Pre-liquidation announcement opportunities

A possibility at higher returns can be had through an investment in funds that are currently being attacked by activists. Some of the usual suspects in such activist attacks are: Bulldog Investors, City of London Investment Group, Saba Capital Management, Karpus management as well as a few others. Usually at this point the returns are slightly higher than the 5% or lower “after liquidation announcement,”-type returns. Maybe the discount to NAV is in the 7-10% range.

Third Level Thinking on Activist situations

A third level of thinking on closed-end fund activists is just to buy a poorly defended closed- end fund trading at a mid-teens + discount to it’s NAV. There are probably more closed-end fund activists in the current markets then there ever have been. There is an increased prospect of activists swooping in on highly juicy yields to the benefit of coat-tail riders. The risk is that you are likely buying into funds that either have terrible management or terrible management fees (or both) and no activist takes notice. If successful returns in this arena can be much higher but there is greater uncertainty (not risk but uncertainty).

Unusual characteristics of an Investment in closed-end fund liquidations

Some things to think about with an investment in this asset class. Unlike in regular investing, variance in stock prices of the underlying securities matters quite a bit because the only valuation input into an investment in a widely diversified closed-end fund that makes sense is the actual trading value of each security added up.

The underlying assets as a whole must be glanced at for their overall risk. On average bonds are a “safer” investment than stocks. This was certainly true before the financial crisis. Now however most bonds are probably quite risky from the perspective of short-term investors (which in the case of closed-end fund liquidations we would be). Closed-end bond funds during most time periods would be considered like-wise less risky (certainly in the price-heavy academic sense). Certain funds in emerging markets would be considered more risky, all else equal, than their developed market counterparts. Etc Etc. There is a lot more short-term risks than long-term investors are usually accustomed to in this field of investment.

Many Closed-end Funds have strong income components. Some funds in liquidation/being engaged by activists have high single digit dividend yields. This allows an investor to shift focus away from the time component of the investment. An investor in a liquidation situation where a fund pays no interim dividend that trades at a discount of 5% would need the fund to liquidate in 5 months in order to achieve a 12% rate of return whereas an investor in a fund that also trades at a 5% discount but pays a dividend of 6% per year could hold the position for 10 months and still achieve a similar annualized return.

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