Written by Nick Ackerman, co-produced by Stanford Chemist. This article was originally published to members of the CEF/ETF Income Laboratory on April 10, 2022.
If you are an investor in Special Opportunities Fund (NYSE: SPE), your position may have become a bit smaller. If you’re like some other investors, your position grew after you bought back more shares. They recently completed their purchase offer, by purchasing a limited number of shares at 97% of net asset value. I was in the camp of using this opportunity to increase my exposure to the fund.
While 97% is a slight discount to NAV, it was still above where the fund was trading. The redemption price was $15.69; the shares ended at $14.97 on April 1, when the tender offer expired. Generally, we see a decline in stocks after the tender offer. In this case, it doesn’t appear that the discount tightened significantly for this to happen with SPE.
This fund is quite unique. They invest most of their capital in other closed-end funds. However, they also have a large allocation to “Special Purpose Acquisition Vehicles”. SPAC exposure is not too large in the fund, but exposed enough to still potentially produce gains. They also have some exposure to common stocks and preferred securities. Bonds and warrants are there, but not a large allocation at this time.
Since our last update, the fund has also completed its rights offering for the preferred shares we discussed. They had redeemed all outstanding shares that had not been converted in time. The preference they use for leverage can be a bit more expensive compared to borrowing from a credit facility. However, it also means more flexibility in times of market crash. It also means fixed rates, which can be beneficial when interest rates rise. Because of the convertible feature, they were able to get away with a 2.75% dividend.
- Z-score over 1 year: 0.34
- Discount: 8.8%
- Distribution yield: 9.28%
- Expense ratio: 1.57%
- Leverage: estimated ~23.9%
- Assets under management: estimated at $243.84 million
- Structure: Perpetual
SPE “uses an opportunistic investment philosophy with a particular emphasis on investing in discounted closed-end funds, undervalued operating companies and other attractive special situations, including risk arbitrage and securities in trouble”.
The fund grew a little due to the conversion of previous preferred shares and then the issuance of new preferred shares. However, I have only estimated leverage and the amount of assets under management at this time. They listed 12,712,964 shares outstanding at the end of March 31, 2022. I then subtracted the 1.25 million shares they bought back. This would equate to approximately $185.47 million in net assets at present based on a diluted net asset value of $16.18. They also raised approximately $58,373,850 from these new favorites.
The fund’s expense ratio is 1.57%. Since they hold other CEFs, the underlying holdings will also have their own expense ratios. This would increase actual expenditures. This is also a consideration with fund leverage. Many of their underlying holdings will also include leverage.
Performance – Discount is attractive
Since the beginning of the year, the fund has suffered a little. This has basically been the most investment story of the year. The graph for SPE may look a bit unusual when looking at the NAV. This is because they only report the net asset value once a week, not daily like most other funds do.
As a reminder, the whole story of SPE is not really important. The fund was originally launched on February 19, 1993. At the time, however, it was the Municipal Assured Income Fund. On December 21, 2009, when Bulldog Investors took it over, they then changed their investment objective to total return on January 25, 2010.
Thus, the performance from January 25, 2010 to today is the most important period to examine. Since then, the fund has generated respectable returns. In the chart below, I’m also including the SPDR S&P 500 Trust ETF (SPY) and the Vanguard Total Bond Fund (BND) for context. These are not necessarily appropriate benchmarks. I don’t know of any other fund that would be most appropriate to compare in this case. Saba Capital Income & Opportunities Fund (BRW) may be more relevant in the future for comparisons.
The fund’s discount based on the NAV per share as of April 22, 2022 would amount to approximately 8.8%.
Be that as it may, the discount is still quite attractive compared to its historical level. Over the past ten years, the fund’s average discount has been 10.59%. This makes SPE not too expensive but not necessarily cheap right now either.
Distribution – Predictable income
One thing that closed-end funds are known for is the large distributions they pay out to shareholders. They may pay higher distributions due to the payment of income, gains and returns of capital. Along with SPE, they also have an 8% managed payout plan in place. This is reset each year based on the net asset value per share at the end of the previous year. For 2022, this meant a monthly rate of $0.11 based on the net asset value of $16.55 at which the fund ended on December 31, 2021.
This all works out to a payout ratio of 9.28% today. As the net asset value has decreased since the beginning of the year, the net asset value rate has increased to approximately 8.54%. So that would indicate that if they don’t make gains for the rest of the year, we might see a reduction. That being said, I think predictability can be a positive and isn’t necessarily a negative – even if it involves yearly adjustments.
To cover this distribution, we found that the fund had to rely heavily on capital gains to fund the payment to shareholders. Net investment income is not that high, despite the large exposure to CEE. The NII had also decreased year over year.
We also find that the amount of distributions paid to shareholders had increased quite significantly. It was for two reasons. The first was the conversion of preferred stock into common stock. The second was that they increased their managed plan by 7-8%.
Despite what the income above shows for the fund, the majority of the distribution for 2021 has been classified as ordinary income. It’s important to check the tax classifications as they don’t always match the income and earnings we see in the breakdown above.
At the end of 2021, they reported that investment companies accounted for almost 50% of their exposure. Investment companies are other closed-end funds.
This was a decrease from the last time we reviewed the fund. In addition, the SPAC exposure had also decreased in its weighting. One of the reasons for this seems to be that investments are based on a percentage of net assets. In our previous article, they still showed some of their favorite leverage in circulation. With this update, they had redeemed but not yet issued the new favorite.
Overall, however, the allocation remains fairly consistent with similar relative weightings. This is despite the 80% portfolio turnover rate they had in fiscal year 2021.
Next, we can take a look at the top ten titles. They don’t provide a list of the top ten holdings, but all of the holdings can be found in their annual report. With the caveat that they have now raised new capital through the preference and gone through a takeover bid, meaning the fund has changed a lot since then.
Their largest position was in General American Investors (GAM). This was a position of $12.72 million, or about 6% allocation before. The actual allocation would have been reduced since then, unless they increased the shares further.
Next we have Central Securities (CET) as the second largest holding, with approximately $12.411 million invested or an allocation of approximately 5.9%.
Then we also have the Boulder Growth & Income Fund (BIF), which recently underwent its own transformation. The fund was renamed SRH Total Return Fund (STEW) and received a new ticker. This was announced on March 25, 2022.
The Board approved the change as it believes the new name better describes the Fund’s investment objective of providing total return to investors. The board also agreed that the change was appropriate to remove the geographic reference in the name, as an association that no longer applied to either Paralel Advisors LLC or Rocky Mountain Advisors, LLC, the investment advisor and sub -respective investment adviser of the Fund. There are no changes to the investment objectives or investment strategy of the Fund.
These positions have been in the fund’s top 10 for several years. One of the neat things about these funds is that STEW pays quarterly distributions, while GAM and CET are semi-annual. In SPE, you can gain exposure to these funds and then receive a monthly payment. For some investors, the frequency of payments is an important factor.
SPE remains a unique CEF which can be great for some investors. I think SPAC exposure is attractive but doesn’t weigh too heavily on the portfolio. The discount is attractive, as well as the predictable payouts for shareholders. The fund holds other CEFs that might not be go-to funds for income investors, but SPE is turning them into more regular payers, so to speak.