Bond fund managers including Eaton Vance, Pioneer and Nuveen are stepping up efforts to redeem auction-rate preferred securities for investors, choosing to incur short-term costs rather than risk long-term damage to their franchises.
Noticeably absent from the redemption activity is Pacific Investment Management Co.
Auction-rate securities are debt obligations issued by municipalities, non-profit entities and closed-end mutual funds. Interest rates on the securities are set by periodic auctions, based on investor demand. When the credit crunch hit, the $300 billion ARPS market froze. Dealers exited the market and investors who once believed these instruments to be almost the same as cash investments were left with securities they could not sell.
The problem for many managers of closed-end funds is that redemptions pit the needs of their preferred shareholders against the need of the common shareholders.
To redeem the preferred shareholders, managers need to raise cash usually through some combination of issuing debt, a letter of credit or loan and swapping out old securities for new ones. However, the cost hurts common shareholders return. To keep common shareholders return high, managers are forced to boost leverage, which is expensive in current market conditions.
Jonathan Isaac, vice president of Eaton Vance Asset Management in Boston and responsible for the oversight of all of Eaton Vances closed-end fund products and trading in the secondary market, said the firm was committed to enabling preferred shareholders to redeem their outstanding ARPS.