Shareholder Activism: Reviewing the Opportunity in Closed-End Funds

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Earlier this week, the Financial Times reported that "Hedge funds circle struggling UK investment trusts".

According to the FT, closed-end funds' significant discount to NAV and competition from low-cost alternatives (as well as their unhelpful positioning within the UK's creaking equity market index) have made said funds an obvious target for certain institutional investors, notably shareholder activists.

As a recap, the closed-end activist trade goes something like this:

• Build up enough nominal ownership in the target fund through direct equity shares or derivatives.
• Strongly encourage management to repurchase shares, perhaps by borrowing money (and in the process, re-leveraging the balance sheet and boosting the company’s return on equity).
• Occasionally, sell short the individual underlying fund holdings so as to tailor one's exposure exclusively to the fund and not the securities said fund owns.
• Wait for the price per share and net asset value per share to converge.
• In rare circumstances, vote to wind down the fund, in turn liquidating the NAV into cash returns (ex-taxes, transaction and wind-down costs) back to owners.

Our high-level thoughts on closed-end funds today

Within the last few months, the team here at Fighting Financials have collated and analysed the broad US and European listed universe of closed-end funds (comprising some £200bn of market capitalisation in the UK alone).[1]

Today, the most appealing investment opportunities available in closed-end funds relate less to using activist agitation to close a given fund's discount. Instead, we think the opportunity lies more specifically within select corners of the closed-end universe, where investors can:

1. Buy credit-focused closed-end funds which have the potential to generate equity-like returns.
2. Buy closed-end debt at very low LTVs but offering double-digit yields.

In these scenarios, the activist playbook represents a “nice to have”, an optional tool within the closed-end fund investor’s toolkit, but not absolutely necessary to generate attractive risk-adjusted rewards.

For clients

For Fighting Financials clients, click here to access our full set of reports on and active recommendations within the closed-end fund sector. Alternatively, please reach out to schedule a meeting or call to discuss our analysis in more depth.

Meanwhile, for prospective clients interested in accessing our full investment research service, please click here or reach out at info@fightingfinancials.com for an initial, no-obligation discussion.

Until then, happy hunting!

The FFL Team

Notes

[1] “Hedge funds circle struggling UK investment trusts”, Financial Times, published 5^th April 2024