Closed-end Funds a Hot Ticket

After taking a beating last year, closed-end funds are offering the biggest discount since 2009, luring hedge fund investments.

Hedge-fund firms Saba Capital Management LP and Pine River Capital Management are piling into closed-end debt funds with share prices that plunged below the value of their assets by the most since the credit crisis.

Saba, the $3.9 billion manager run by Boaz Weinstein, has amassed at least $847.3 million in the publicly traded funds after it started buying them last year, moving into an area traditionally dominated by individual investors, regulatory filings show. Pine River purchased $159.6 million of shares that on average fell as much as 9.1 percent below their holdings in December, the biggest gap since 2009 as measured by Thomas J. Herzfeld Advisors Inc.

Hedge-fund managers are seeking an edge in a market where the riskiest corporate debt is typically yielding 6.06 percent, 3 percentage points less the average of the past decade. They’re stepping into funds run by BlackRock Inc. and Pacific Investment Management Co. (Pimco) after retirees and wealthy individuals fled last year in the face of a Federal Reserve pullback from unprecedented stimulus.

“A tremendous amount of money has been invested by non-traditional institutional investors, including hedge funds,” said Cecilia Gondor, executive vice president at Herzfeld Advisors in Miami Beach, Florida. “Retail investors are still nervous about investing in interest-rate-sensitive securities.”

Individuals accelerated their sales of closed-end funds in June after then-Fed Chairman Ben S. Bernanke laid out a plan by which the central bank would reduce its monthly asset purchases. Dollar-denominated junk bonds plunged 2.6 percent that month, and investment-grade notes dropped 2.8 percent, according to Bank of America Merrill Lynch index data.

The biggest closed-end credit funds outstripped even those losses. Pimco’s $2.77 billion Dynamic Credit Income fund sunk 3.7 percent in June, and DoubleLine Capital LP’s Income Solutions fund dropped 6.56 percent, according to data compiled by Bloomberg that includes reinvested dividends.

While speculative-grade bonds subsequently rebounded, gaining 5.8 percent in the following six months, closed-end funds have lagged behind.


‘Beaten Up’

Individual investors, concerned that funds that use leverage are vulnerable to bigger losses as bond yields rise, continued to sell their shares into year-end, according to Sangeeta Marfatia, a strategist at UBS Securities LLC in New York. They also were driven by efforts to lower taxes by locking in losses at year-end, she said.

“Closed-end funds got beaten up pretty bad,” Marfatia said in a telephone interview. Even with the drop, she doesn’t necessarily view the discount in the shares as a buying opportunity. “Closed-end funds use leverage, and interest rates are rising,” she said.

Shares of the investment vehicles dropped as much as 26.2 percent below the average value of their holdings in the depths of the financial crisis in October 2008 as investors fled strategies that use borrowed money, Herzfeld Advisors data show. They usually trade at some discount to the value of the underlying assets.

Hedge-fund firms that typically seek to exploit inefficiencies in the debt markets are now swooping in as yields on 10-year Treasuries retreat to 2.67 percent from 3.03 percent at year-end, and as yields on riskier debt return to almost record-low levels.

The magnitude of Saba’s recent purchases of the fund shares is unprecedented, according to Warren Antler, who specializes in analyzing closed-end funds at AST Fund Solutions LLC in Lyndhurst, New Jersey.

“You’ve got a big hedge fund buying into this space,” he said in a telephone interview. “This showed up in the last quarter.”

Saba, which former Deutsche Bank AG credit-trading co-head Weinstein started in 2009 to trade on price discrepancies between securities, last year purchased $75.7 million of shares in Pimco’s Dynamic Credit Income Fund to become the biggest single holder of the fund’s securities, Bloomberg data show.

The hedge fund bought $78.5 million of shares in the BlackRock Corporate High Yield Fund VI to become its second-biggest owner. The firm now owns $41.5 million of shares in BlackRock’s Credit Allocation Income Trust, becoming its fourth biggest owner, the data show.

Pine River, founded in 2002 to pursue opportunities in relative-value trading globally, bought almost 1.1 million shares of Pimco’s Dynamic Credit Income Fund, valued yesterday at about $24.4 million, in the three months ended Dec. 31, filings show. It bought 1.1 million shares in BlackRock’s Corporate High Yield fund and 1.4 million of DoubleLine Income Solutions Fund shares in the period, the data show.

The Pimco fund rose 0.8 percent today to $23.07 as of 12:58 p.m. in New York, the biggest increase this year. BlackRock’s fund climbed 0.2 percent to $12.46, the highest since Dec. 26, while DoubleLine’s added 1 percent to $21.38, the highest since October.

While Pine River owned some closed-end fund shares at the end of 2012, more than 70 percent of its purchases were made last year, filings show.


Exploiting Gaps

Jonathan Gasthalter, a spokesman for Saba, and Patrick Clifford, a spokesman for Pine River, declined to comment.

Relative-value hedge funds make both bullish and bearish wagers to profit from price discrepancies between securities. The funds are wagering that the shares have plunged too far below the value of debt that’s rallied in the face of weaker-than-expected economic data, which has lowered expectations for how much Treasury yields will rise this year.

Pimco’s Dynamic Credit Income Fund has gained 3.2 percent this year including reinvested dividends, while BlackRock’s Corporate High Yield fund has returned 2.8 percent, Bloomberg data show.

“We’ve seen a bounce back,” UBS’s Marfatia said. “People are attracted to the value proposition, but they also sold off so much that they had to step in and buy some of this.”

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