Featuring:
Christopher Hayden
Chief Operating Officer, U.S.
Georgeson LLC
Dennis Emanuel
Managing Director
Chatsworth Securities LLC
Many closed-end funds continue to face activism which is often focused on short-term actions that may not benefit the long-term strategy of a fund – and limited shareholder participation in proxy voting can give activists outsized influence. In this two-part discussion, learn about the importance of shareholders participating in proxy voting from Georgeson’s Chris Hayden and typical activist proposals and the potential impacts on a fund from Chatsworth Securities’ Dennis Emanuel.
About Georgeson LLC
A Computershare company, Georgeson is a global provider of strategic shareholder engagement, proxy solicitation and governance consulting services. Learn more here.
About Chatsworth Securities LLC
Chatsworth Securities is an investment banking firm that provides a wide range of services to institutional clients including financial advisory and capital raising expertise with a focus on closed-end funds. Learn more here.
Transcript
CEFA:
Welcome to CEF Insights, your source for closed-end fund information and education brought to you by the Closed-End Fund Association.
Today, we will first speak with Chris Hayden, Chief Operating Officer – U.S., for Georgeson LLC regarding the importance of shareholder voting. A Computershare company, Georgeson, is a global provider of strategic shareholder engagement, proxy solicitation, and governance consulting services. We will then discuss the increase in activist shareholder activity among closed-end funds with Dennis Emanuel, Managing Director with Chatsworth Securities. Chatsworth provides financial advisory and capital raising expertise for the asset management industry with a focus on closed-end funds.
Chris, welcome to our CEF Insights podcast.
Chris Hayden:
Thanks. It's great to speak with you today.
CEFA:
Chris, we are in the middle of proxy season for closed-end funds and investors have been receiving proxy documents by mail or email. How important is it that each shareholder takes some time to vote?
Chris Hayden:
Thanks, that's an important question. Closed-end funds are required to have an annual meeting each year, and at the annual meeting, directors or trustees are typically elected. Often, there are other matters to be considered by shareholders, and in order to conduct business, typically a majority of the outstanding shares must vote at the meeting. This minimum threshold is called a quorum. As such, it's important for investors to vote so that the fund can obtain a quorum and conduct business, and without a quorum, no business can be conducted at the annual meeting. Many years ago, brokers would vote on behalf of their clients and obtaining a quorum wasn't an issue. However, many large brokers no longer will use discretionary voting to vote their clients’ shares on the election of closed-end fund directors. The onus is now on the individual shareholders to actually vote.
Furthermore, in the closed-end fund space, there are institutional activists that have special interests. Dennis will talk more about the activists in a moment. The voice of the retail holders is more important than ever because of these activists that often have their own agenda. The activists will rely upon the apathy of retail holders to help drive their own agenda. We often see circumstances where activists with relatively small ownership positions are able to drive the agenda because of this retail shareholder apathy.
CEFA:
Chris, you have been working with funds for many years. What is the level of shareholder voting typically, and what, if any, challenges does this present?
Chris Hayden:
Sure, that's a great question. In a typical uncontested meeting where the fund mails or emails just a single communication, the retail response rate is typically around 25% to 30%. Institutional holders and the handful of brokers that still permit discretionary voting will help get the necessary votes on items deemed routine by the New York Stock Exchange. Routine items are items such as the ratification of auditors and uncontested director elections. When the fund has a non-routine item on the agenda, they may consider using a firm like ours to help drive the vote. We can typically increase the return response rate to 50% or so using a combination of oral voting i.e., when a proxy solicitor takes a vote over the phone, and also with multiple mailings and emails. However, when there's a contested situation, we are no longer able to take oral votes. This makes each vote that much more important. And again, an activist with a small position can affect change because retail holders often don't vote.
CEFA:
What is the potential impact on the shareholders' investment if voting participation is limited?
Chris Hayden:
Sure, there are a couple of significant impacts. First, when shareholders don't vote, the costs for the fund and, ultimately, the fund's shareholders go up as the fund then need to send out multiple mailings and make calls to individual holders. Additionally, activist proposals may not be aligned with the interest of long-term shareholders, but the activists take advantage of what is often limited voter turnout to have an outsized impact on the shareholder vote and the resulting fund policy.
An example of that would be when a group of activists with say, 27% ownership can win approval of their proposals if only 53% of the shares vote. The remaining 47% of shareholders that didn't vote are subject to the will of a minority of the activist shareholders.
The most important aspect of robust shareholder voting is that the fund is maintained and continues to operate in accordance with the interest of the true majority of investors. Ultimately, this protects shareholder interests.
CEFA:
Chris, thank you for being with us today.
Chris Hayden:
Thanks. It was great to join you today.
CEFA:
Activist shareholders and contested proxy proposals have been part of the closed-end fund landscape for many years. However, in recent years, closed-end funds have faced increasing challenges with an upsurge in hedge fund and institutional activism. We are joined by Dennis Emmanuel to discuss this activity.
Dennis, thank you for joining us.
Dennis Emanuel:
Well, closed-end funds, they've always had to deal with activists, but the increase in many years is due to a combination of reasons. The first, market conditions, closed-end funds trade at historically wide discounts. The typical fund trades hundreds of basis points wider than the long-term average. This is largely due to the aggressive Fed policy of raising overnight rates more than 500 basis points over the past two years. But it goes further than that. Like all things closed-end fund activism has evolved.
20 years ago, activists were relatively small institutions that would go after the tiny funds that traded at deep, normally double-digit discounts, hoping to get a liquidity event such as a tender offer. Fund assets back then used to provide a layer of protection. Essentially, the bigger the fund, the less likely it was in danger of being targeted by an activist because it would take quite some time and quite a bit of capital for an activist to gain enough of a position to be disruptive. That's no longer the case in the current market. Larger institutions, namely hedge funds, have made their way in. Now a fund with a billion or more in assets is no longer shielded. And this new breed of hedge fund activist, they're capable, they have the means to target multiple funds simultaneously.
CEFA:
What type of corporate actions would an activist shareholder typically push for and what could this mean for most shareholders?
Dennis Emanuel:
Well, as far as corporate actions, they're typically looking for some sort of liquidity event, and there are basically three, a tender offer, conversion to an open-end fund and a liquidation. Now, each of these has the potential to have tax implications for the investors because securities need to be sold. In the case of a small tender offer, any tax implications may be negligible, but if you talk about a liquidation of a fund, this could be very meaningful. So, let's talk about tenders. Historically, tenders have never ever been effective in narrowing a fund's discount other than in the very short term. When a tender offer is announced the discount narrows because current or new investors are trying to take advantage of buying the fund at the current low price and receiving the much higher NAV. The problem is, unless it's a tender for a hundred percent of the shares, not everyone is going to get their full allotment.
So, the selling pressure then tends to widen the discount out once again. Meanwhile, depending on the size of the tender, securities will need to be sold, which can have a negative impact on a portfolio. So, if you're a leveraged portfolio, the leverage ratio can increase forcing the fund to take off some leverage, and that's going to have an impact on the distribution as well as the NAV return. For a fixed income fund and depending on the market rate environment, and maybe not so much in today's environment, but reinvestment risk can creep into the portfolio and certainly for equity funds with managed distributions, a smaller portfolio could pressure the payout because these funds rely on gains.
Conversion to an open-end fund, that can have negative implications on a distribution and its returns because if a closed-end fund is leveraged, they have to take that leverage off. Open-end funds cannot leverage. In either case, leverage or non-leverage portfolio has to be managed a little bit differently to account to maintain some cash in case of redemptions and having cash on hand could cause a little bit of cash drag.
And speaking of redemptions, what we tend to see is that anyone that didn't want to be in the open-end fund, if they didn't get out and sell out before the conversion, they tend to redeem shares afterwards once the lockup period is over with. Now, with the final one, the liquidation, the biggest problems there are certainly tax related, but also the need to reinvest the assets in something with a similar yield or investment objective. I'd also add that if you have a very large liquidation of assets, the cost associated with that could negatively impact NAV and shareholders could be getting a lower NAV than they anticipated.
CEFA:
Dennis activist investors sometimes look to replace the board of directors with their own nominees. What is the impact of this kind of change if the activist is successful?
Dennis Emanuel:
Well, remember when I said that closed-end fund activism was evolving or has evolved? This never really used to be a problem, but the new breed of activists is bigger, more sophisticated, and taking advantage of what Chris mentioned earlier, namely that many large brokerage firms no longer use discretionary voting to vote for their clients. And the roughly 25% to 30% that he had mentioned, that participation of shareholders, that's simply not enough. So, there is an opportunity for activists to exploit. So, what's the impact of this? Well, typically if an activist is successful in placing their own nominees onto the board, they're looking for one thing and they're looking to replace the fund advisor. Now, that could be a good thing if a fund is truly underperforming for a very long time but how do you determine under-performance? Trading at a discount does not necessarily mean a fund is underperforming.
Sometimes a category is just out of favor. I mean, I can point to several categories right now, today that are trading at significantly wider discounts than the average closed-end fund. So, if you're going to compare a fund's performance to its peers, which is really the proper way to do things, I'd like to see consistent under-performance for a very long period of time before we start talking about replacing the management. But if replacing the management is a consideration, I think the prudent thing is to replace existing management with a team that has expertise in the fund's strategy. And this is not what we've seen in a few instances where the management contract has been canceled and the activist ends up managing the fund and changes the investment objectives. Now, this is not in the best interest of a shareholder because they purchased this fund with a specific investment objective, and this is just for the average investor, not a good thing.
And when you think about it, all that's really occurring in these instances is the activists, how can I put this? They're opportunistically acquiring assets and at extremely attractive levels, and mostly for their own benefit because now they'll own the management contract and the fees that go along with it, and they can all do this with very minimal effort. And then lastly, we've seen a few cases of this, and I can think of four off the top of my head. Well, let me use three because one of them happened at the end of the year. It's only been a few months, so I'll eliminate that one. But these other three funds still trade at big discounts, wider than the closed-end fund average, and two of them trade significantly wider than the closed-end fund average.
CEFA:
Are you seeing any other issues caused by activists that are impacting shareholder voting on proposals for closed-end funds?
Dennis Emanuel:
Yes. Recently we've seen activist shareholders, they're looking to obstruct business of closed-end funds even if they have little to no interest in the fund itself. Basically, what they do is they initiate proposals or recommendations in opposition to the fund management, and it makes acquiring sufficient shareholder votes more difficult. Now remember what Chris said earlier, when a proposal is contested, a proxy solicitation firm cannot take oral voting. This is just going to make things more difficult and increase the cost of mailings and potentially delaying the vote.
And actually, we could talk about an example that's going on right now. I'm not going to get into the names or too much specifics, but this is a fund that has a term on it, and it's set to terminate, which means liquidate, at the end of the summer. The fund sponsor has proposed to its shareholders to eliminate the term, so it can go on in perpetuity. Now, if the proposal is approved, the fund will still conduct a tender for 100% of the shares. And if a specific level of assets remain after the shares are tendered, the fund will go on as a perpetual fund. If less than that designated amount remains, the fund will liquidate. In addition, if the proposal is passed, the fund will also waive 50% of the management fee over the next year. So, think about it, every aspect of what they're proposing is in favor of the shareholder. There's no downside whatsoever. And when I say downside, I'm not talking about market risks. This is literally a win-win for the shareholder. However, an activist that didn't previously own shares acquired a position and is now contesting the proposal. The activist doesn't even qualify to vote on the proposal because they acquired the shares too late, but it's still soliciting shareholders to reject it. The rationale is just perplexing.
From an investment standpoint. There's little to gain. This fund has traded for quite some time now at a pretty narrow discount. So, what's the motivation? All they've accomplished is increasing legal costs, prolonging the vote, which now has been extended a month, and no doubt confusing investors. So, I would say contesting for the sake of contesting, does absolutely nothing for the average shareholder and is certainly not in their best interest. It's a negative side of fund activism. I hope it doesn't turn into a trend. But I think the biggest takeaway here, from everything I've said and certainly everything Chris has said, the average closed-end fund investor has to understand that your vote is important. It is very important. Don't ignore it. Don't rip it up, because there are activists out relying on you to do so, so that they can take advantage.
CEFA:
Dennis, thank you for joining us today.
Dennis Emanuel:
My pleasure. Thank you.
CEFA:
And we want to thank you for tuning into another CEF Insights podcast. For more educational content, please visit our website at www.cefa.com.
Podcast recorded April 2024.
Disclosure
This material is not, and is not intended as investment advice, an indication of trading intent or holdings, or the prediction of investment performance. All fund-specific information is the latest publicly available information. All other information is current as of the date of this presentation. All opinions and forward-looking statements are subject to change at any time.
Computershare and Chatsworth Securities disclaim any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, Computershare and Chatsworth do not warrant its completeness or accuracy. This presentation is not intended to and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service, nor shall any security, product, investment advice or service be offered or sold in any jurisdiction in which Computershare or Chatsworth is not licensed to conduct business and/or an offer, solicitation, purchase or sale would be unavailable or unlawful.