Boaz Weinstein, founder and Chief Investment Officer of Saba Capital Management (Saba), has been crystal clear about his plans to hijack ten of BlackRock’s closed-end funds (CEFs). He’s looking to take control of these funds and push for significant change – including ousting management at six funds. However, what he isn’t clear about is how this will come at the expense of middle-class Americans who rely on these funds. 

Unfortunately, this battle isn’t new. Corporate assailants like Saba Capital have been working around a loophole in a decades-old law to hijack CEFs to enrich themselves under the banner of “corporate governance” while derailing the average investors’ returns. If this loophole isn’t taken care of, it will deprive retail investors of a critical tool and have a chilling effect on the broader capital market. 

Though Weinstein claims to be a “champion for the retail investor,” Saba’s affection for short-term gains doesn’t align with the average CEF investor. The latest data shows that over 3.8 million US households hold closed-end funds (CEFs). Of the households that own CEFs, the median household income is $100,000. These are middle-class Americans who are being targeted due to the features of closed-ends that make them popular for the average investor. 

CEFs are professionally managed and can invest across public and private markets, giving access to less liquid assets with higher yields. This exposure offers the potential for more diversification. CEFs typically also provide a steady flow of distributions to shareholders, making them appealing to small businesses, retirees, and other people who might need a constant cash flow.

Unlike with open-end funds, the issuer of a CEF doesn’t issue or redeem new shares in the fund. That means CEFs don’t have to worry about being forced to sell off their positions to meet demand from a flurry of investor redemptions, giving the fund manager more space to make long-term decisions for the portfolio. However, that lack of liquidity can often drive the market price of the shares in the fund below the net asset value (NAV) of the underlying assets that the fund owns. 

The possibility of discounted market prices opens the door for activist investors like Saba to come in and accumulate shares at below-NAV prices and push for a liquidity event. A liquidity event could mean several things, such as a fire-sale of the assets contained in the fund, potentially at an inopportune time, or even converting the closed-end fund to an open-end fund. 

When activists like Saba succeed in taking over a CEF, they almost always immediately push for some kind of liquidity event to narrow the discount between the CEF’s market price and the underlying value of the assets it invested in. This could sound appealing initially since it promises a quick bump in the fund’s market price. But in reality, it has consequences that aren’t always immediately apparent. Some of these include an ill-timed taxable event due to liquidation, reinvestment into riskier asset classes with higher fees, or general disruption to the CEF’s advertised strategy. Such a sharp change in direction for a given fund amounts to a “bait-and-switch” for the existing long-term retail investors that should concern government regulators.

It’s not hard to see why this is problematic to both investors and their earnings. These actions by Saba and others are harmful to returns and threaten the future existence of CEFs. 

The death of CEFs –becoming more likely should these actions continue – would eliminate a unique and valuable asset class especially popular with retirees and middle-class investors. CEFs allow the average investor to put some of their capital into private investments, such as real estate, startups, private equity funds, and more. This is one of the only ways many retail investors get access to these kinds of investments that are typically reserved for high-net-worth individuals or professional investors. For the startups and other companies that often receive investment from CEFs, the death of such funds would mean less capital to fuel innovation, research, and progress. 

These important funds are being hijacked, and we must protect middle America from these activist companies. 

Congress has introduced legislation to close the loophole allowing these activist companies to take over funds. The Increasing Investor Opportunities Act (HR 2627) passed the House of Representatives in March with bipartisan support, and would “amend the Investment Company Act of 1940 to prohibit limitations on closed-end companies investing in private funds, and for other purposes.” The goal would be to apply the same restrictions to private funds that are already applied to registered funds.

If this loophole remains and Saba is successful, the people who invested in these funds thought they were buying one thing, only for the fund to be hijacked and go in a totally different direction. This could be detrimental to financial performance, not to mention frustrating for the investors. Already Saba’s performance has not been impressive. Their prior attacks on PPR and GIM resulted in both funds losing approximately 50% of their assets since Saba first engaged those funds. There is no reason to assume BlackRock’s funds will be any different if they’re successful in overtaking them.

Closed-end fund investors are decidedly retail and middle-class. Saba Capital is taking advantage of a loophole to the detriment of middle-class Americans. For the future of CEFs and the protection of the everyday investor, these loopholes must be fixed. 

This was published in The Economic Standard.