Closed-end ETF quietly yields 15% and outperforms most bonds

Quick reading

• CEFS ETF offers a 15% year-to-date return and a 6% return by targeting closed-end funds trading up to 15% below their net asset value.

• Boaz Weinstein’s Sabra Capital uses proxy battles to force share buybacks and fund conversions, actively closing NAV discount gaps to turn a profit.

• An expense ratio of 2.61% and fewer than 100,000 shares per day make CEFS more expensive and potentially illiquid than most comparable ETFs.

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Closed-end funds (CEFs) and exchange-traded funds (ETFs) are investment groups listed on major US stock exchanges and focus on very specific financial themes, such as high dividend yields, technology, real estate, energy, international markets, and a wide variety of other sectors. However, there are some differences between them, such as:

• ETFs are typically passively managed and track a designated index, while CEFs are inevitably actively managed and subject to the discretion of the portfolio manager.

• ETFs use derivatives, such as covered calls, as their first-choice tool for generating dividend income. CEFs and their managers tend to favor the use of margin leverage to improve profits and revenues.

• ETFs have a variable number of shares, similar to open-end mutual funds, while CEFs have a fixed number of shares.

• ETFs trade relatively close to their net asset values ​​(NAV), while CEFs can trade at a premium or discount to NAV.

Sabra Capital Management Sabra Closed-End Fund ETF (CBOE: CEFS) there is the odd duck: an ETF that invests in CEF. However, it has a specific goal in mind: to take advantage of arbitrage opportunities when a CEF trades at a discount to its net asset value.

NAV Closed-End Fund Arbitrage

Net asset value is a sometimes overlooked metric in the fund space. Basically, NAV is the total value of a fund minus its liabilities and then divided by the total number of shares. Due to their fixed number of shares, CEFs can sometimes trade at a discount to their underlying net asset value. Eagle-eyed investors who see these discrepancies can take advantage of an arbitrage opportunity: effectively buying assets at between $0.85 and $0.94 per dollar. This intrinsic value can pay off in a trading scenario if the CEF moves into overvaluation territory due to increased buyer enthusiasm, or it can be a fixed profit if one wishes to continue an uptrend.

The entire strategy of CEFS, the ETF, is to look for and take advantage of these arbitrage opportunities. Launched on March 21, 2017, the details of the CEFS at a glance are as follows, based on the market at the time of writing:

Fair Value and Profit Activism

Sabra’s combination of a clever CEF discount in the NAV acquisition process and a proxy battle to force boards to close the NAV gap is unique on Wall Street.

While it is true that many investors can recognize NAV arbitrage buying opportunities and take advantage of them, there is usually little they can do about it until the market recognizes the discrepancy and closes the gap. Sabra Capital Management’s dual approach is:

1. Identify and acquire large equity stakes in undervalued CEFs.

2. Sabra then uses its financial influence, its legal knowledge of the SEC, and its block of shareholders to initiate structural and operational changes in the company through a proxy battle with its board of directors to close the net asset value gap. These changes may include:

• Begin share repurchase at NAV price;

• Force a format conversion to an open-end mutual fund or ETF;

• Liquidate underperforming or delinquent assets on the books.

With its 6% and 15% year-to-date returns, many investors might think Sabra’s approach is attractive and novel. There are two caveats to keep in mind:

• CEFS has a high expense ratio of 2.61%. While the management fee is 1.10%, proxy battles and lobbying activities are capital intensive for legal and accounting fees.

• Average daily volume is less than 100,000 shares daily, so liquidity may be an issue for some investors.

CEO Boaz Weinstein has made the activist approach a core strategy of Sabra Capital Management and has also applied it to BDCs, REITs and SPACs. CEFS is the type of ETF that appeals to investors who enjoy the advantage of the discount and like the idea of ​​watching the discount close and their profits appear, literally in real time.

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