Closed-End Fund Sponsors’ Investor Relations Practices and their Role in Secondary Market Support: (Article and Video)
How well we are able to analyze a fund depends a lot on what information the fund managers provide us with. It is important for a fund to have a good reputation amongst retail and institutional investors and often how they handle investor relations determines that reputation. There is a wide range of different types of investors. Managers need to be able to understand how to communicate with all of them in order to compete with other structures, ETFs in particular.
Investor relations is the part of the fund sponsor’s work that shapes our ability, as advisors, to access the mangers outlook and positioning strategy in addition to in-depth details about a portfolio’s contents. As a firm, when we build and adjust clients’ accounts over time, this data helps us make our portfolio decisions. Without it, we would be flying blind, not knowing what to expect from a manager over various market cycles.
In our experience CEF analysis breaks down into 3 (three) types. The first is historical NAV performance and current portfolio data, such as country exposure, the mix of small or large cap stocks, and whether there is a focus on growth or value. Second is the manager’s outlook and how he has positioned the portfolio for the near-to-medium term. Lastly, the CEF data points concerning discounts, shareholder base, distribution policy and level, as well as historical and peers averages, also provide a level of transparency. If these data points fail to paint a clear picture of the holdings of a fund, confusion among the ranks of investors and advisors may follow.
In our opinion, in the CEF universe, discounts stem from four main areas: 1. a simple plain vanilla portfolio of liquid investments, 2. Poor Manager net asset value performance, 3. Low liquidity from trade volumes and wide bid/ ask spreads, 4. Confusion among a shareholder base on what they own or what the manager is doing for their benefit.
Unfortunately, there is less coverage of CEFs than one might expect for a 121 year old product in the US with almost 600 funds and near $300 Billion in net assets. Traditionally that has been because CEFs have been sold on the IPO vs. bought in the secondary market. There are few areas of the capital markets that have direct financial interest for when an investor or financial advisor purchases vs. sells shares of a CEF on the secondary market.
We believe wire-house and independent RIA firms billing more commonly on client assets quarterly and less often by the product itself or commissions will allow easier use of CEFs to fill in core and specialty pieces of client portfolio allocations while maintaining compensation to an advisor for ongoing advice vs. a one-time commission. We recommend fund sponsors focus on a blend of good IR/PR and good net asset value results – discounts cannot be addressed without successfully employing both.
Typically CEFs do not do enough advertising and communicating with shareholders and advisors in order to compete effectively with ETFs and other products. Some fund sponsors perform better than others in this aspect. We think it is important to balance the need to speak to investors that fall into different categories; these categories include those passionate about the structure, as well as “cross-over” and “new-to-CEF” investors. We find a successful sponsor covers the fund’s focus or investment objective – a country, region or sector, as well as ongoing education on the CEF structure. This should include webinars, short videos, articles, advertising, and attending conferences both as a vendor and a speaker. Such a strategy can appeal to both those that are experienced with the CEF structure and those that are not. We know the challenge is how to allocate the cost of these endeavors. We think if you have any interest as a fund sponsor in adding market cap thought new shares or a related IPO down the road then this cost can be easily justified.
Some people buy a fund just because it is an “attractive CEF,” others in order to gain access to the manager or sector exposure. We think you need to find and retain both types of investors.
How have CEFs evolved over time? We think that adaptation has been great for the structure. Currently according to our Universe data, there are 585 Traditional CEFs (Universe data as of August 22nd, 2014). 488 (83%) of those have existed for 5+ years, 394 (67%) of those have existed for 10+ years, 251 (43%) have existed for 15+ years and 213 (20%) have existed for 20+ years. CEFs have adapted over time from the 1990’s with a focus on International Equity, the 2000’s with a focus on Equity Income, and the Naut’s with a spilt focus on MLP/Energy or Infrastructure and Low Duration, Loan, High Yield Debt fixed-income funds. Each new modification brings with it a chance to bring new investors to the structure.
After a century of success, we are really excited for what the next 5-10 years will bring to the closed-ended structure. To put the advent of CEFs trading on the NYSE in 1893 into perspective, the year is also known for two other births; the first motion picture studio was built by Thomas Edison in NJ and the first ever recorded college basketball game took place at a YMCA in PA. Which means, CEFs got their start at the same time as Hollywood and March Madness.
In a perfect world what we hope to see from a successful fund sponsor is: 1. Design a compelling and hard to mimic investment objective, 2. Hire a great portfolio manager, 3. IPO enough assets to offer economies of scale and liquidity to investors, 4. Keep us informed along to way so we know why we own equity in your future results and how to position the fund in our client accounts. If the fund sponsor takes these steps, a level of transparency will be created.
A CEF is a liquid way for investors of all sizes and levels of sophistication to gain access to some of the best investment management talent available. The manager raises permanent capital and can invest for the long-term with no concern about liquidity needs from redemption pressures of the open-end fund structure. An investor/advisor being pushed away from the structure because of confusion caused by inadequate IR/PR practices enacted by the fund sponsor is an avoidable circumstance.
There are a lot of ways to invest in today’s market. Competition drives innovation. Each investment company structure: open-end, closed-end, exchange traded, hedge fund and unit investment trust, has its benefits and challenges. It can be challenging for closed-end fund sponsors to implement effective investor relations plans, however, the sponsor being there for shareholders with good investor relations after the IPO is the implied promise of a fund sponsor when raising permanent capital in a closed-end fund.
Good liquidity, analyst coverage, proper use of Rights, Secondary’s and Tenders can help adjust the funds size as needed over time to match supply and demand for the fund in the market. The secondary market is what makes the CEF structure unique. However, in our experience, avoiding the details involved in proper support for a CEF in the secondary markets can lead to confusion and pervasive discounts.
Great CEF Fund Sponsors embrace the structure and prove to investors why they should own the shares. CEF don’t have any lock up provisions, you can trade any moment of the trading day. That is the deal a fund sponsor makes to have the benefits of permanent capital. By giving them the tools needed to successfully navigate the structure; fund sponsors help savvy investors/advisors capture these benefits as well.
Disclosure: The views and opinions herein are as of the date of publication and are subject to change at any time based upon market movements or other conditions. None of the information contained herein should be constructed as an offer to buy or sell securities or as recommendations. Performance results shown should, under no circumstances, be construed as an indication of future performance. Data, while obtained from sources we believe to be reliable, cannot be guaranteed. Data, unless otherwise stated comes from the August 22, 2014 issue of our CEF Universe service.