Attempts by shareholder activists to remove certain key defensive mechanisms embedded within closed-end funds may pose an existential threat to these investment vehicles.
Saba Capital Management on Monday filed a dissident proxy in connection with a special meeting of the Citadel Income Fund, a Canada-based closed-end investment trust, the latest salvo in a broad campaign against closed-end funds trading at a discount.
Saba, a hedge fund based in New York, requested the Sept. 11 meeting in order to seek to replace the current trustee and manager of Citadel, Artemis Investment Management Ltd., and to approve the fund's timely wind-up and liquidation.
"After nearly seven months, we are pleased that Citadel has finally scheduled the Special Meeting so unitholders can have a voice in determining the future of their Fund. Since our prior attempts to engage constructively were effectively ignored, it is clear to us that management has had no plans to address the Fund's status quo of sustained underperformance, prolonged discounts and poor corporate governance," stated Boaz Weinstein, New York-based founder and chief investment officer of Saba, in a release.
"Over the past decade, investors have watched helplessly while management has destroyed the value of their investments with the Fund's discount to NAV plummeting -24.3%. Investors, such as Saba, have been unable to express our views or raise concerns due to management's unprecedented entrenchment provisions and self-serving governance structure," according to Saba's news release.
On June 29, Saba filed a lawsuit in U.S. District Court in New York against 16 closed-end funds advised by BlackRock Inc., Franklin Resources Inc., Tortoise Capital Advisors, Adams Funds and FS Investments that have adopted control share acquisition provisions that limit the voting rights of new shareholders.
Kenneth Fang, Washington-based associate general counsel at the Investment Company Institute, the trade association that represents regulated funds, including closed-end funds, said in an interview he thinks that companies like BlackRock have a strong argument in litigation involving the control-share provisions of closed-end funds.
Activist shareholders, including hedge funds, he said, are seeking to weaken the closed-end funds' defenses in warding off activist attacks. Activists such as Saba Capital Management are acquiring shares trading at a discount and then looking to use new voting power to trigger a liquidity event, which might ultimately lead to the activists exiting the fund at a premium.
"Such events might include a forced tender offer, the forced liquidation of the fund, or its conversion to an open-end fund," Mr. Fang noted.
These tactics, he said, would enable activist investors to realize short-term profits at the expense of the funds' long-term shareholders.
"We think BlackRock has a strong argument in its favor that the control-share provision is consistent with the Investment Company Act," Mr. Fang said. "But in the event that BlackRock loses and is unable to employ key defenses, it might pose an existential threat to closed-end funds."
With respect to BlackRock, Saba has been purchasing shares in three closed-end funds: Innovation and Growth Term Trust; BlackRock ESG Capital Allocation Term Trust; and BlackRock California Municipal Income Trust.
Saba said it sought to invalidate the funds' control share provisions, citing they are unlawful under the Investment Company Act.
Saba noted that it has brought similar lawsuits against Eaton Vance and Nuveen, adding that on Jan. 21, the Suffolk County Superior Court in Massachusetts ruled in favor of Saba by issuing a summary judgment that invalidated Eaton Vance's control share provision as a violation of the Investment Company Act
Upon filing the suit, Michael D'Angelo, partner and general counsel of Saba, stated in a release: "By adopting illegal control share provisions, closed-end fund managers, including BlackRock … are depriving shareholders of their voting rights in desperate attempts to entrench trustees and investment advisors and avoid accountability for their own governance failures."
Saba declined to comment.
Mr. Fang of ICI also warned that new sponsors might become unwilling to introduce new closed-end funds if they think the risk of losing control of the funds to activists becomes too high, depriving retirees of a key source of dividend income.
According to ICI data, 4 out of 5 closed-end funds traded at a discount at the end of 2022, with the average discounts for bond and equity offerings at 5% and 5.7%, respectively. Such discounts make closed-end funds more susceptible to exploitative attacks from activist shareholders.
At the end of 2022, closed-end funds comprised $252 billion in assets, ICI noted.
Mr. Fang said he thinks other activist shareholders will be closely watching the Saba lawsuit in order to see if they want to launch similar litigation.
BlackRock declined to comment on the lawsuits.
