On November 9th, 2010 TS&W / Claymore Tax-Advantaged Balanced Fund (TYW) made a press release broadly observed to reflect directional uncertainty in light of the prospect for changes to the tax code. In reality, there is much more going on with this fund than broadly observed.
The Relevance of Tax Uncertainty is Broadly Shared
There is certainly broad relevance to investors of the possible expiration of, adjustment to, or limited extension of the Bush tax cuts, and more specifically, rates on qualified dividend income (“QDI”). I have even written about my Closed-End Fund thematic positioning for this potential catalyst. Although unheralded by the public still, it’s a big topic across all complexes. Among CEF families, Alpine’s high velocity Dividend Capture Funds (AOD, AGD) has a documented QDI goal. My acknowledgment of their simple disclosure is a relative compliment to governance of which I have been less than supportive (1, 2). Documented strategy details as regards to QDI are highly relevant to the intermediate and long term shareholder demand, and downside valuation prospects of Closed End Funds. Why? Speaking broadly, The Closed-End Fund instrument can prospectively be used as a vehicle of Asset Captivity by advisors when marketplace taste for a particular fund’s approach has waned.
Primary TYW Interest: Observed Activism
Whether there was ever a secondary market taste for TYW is debatable.
What is today the most relevant issue with TYW is what exposed it to be a prospective beneficiary of Closed-End Fund Activism. Among 17 holdings in my account licensed to Covestor’s Well Intentioned Activism Profile Closed-End Funds model, it is the one Closed-End whose investment focus isn’t clearly overlapping my bullish macro perspective on traditional risk-assets. I have conviction TYW has near term upside to its relative valuation with observed Activism being either forcefully successful or otherwise resolved. On November 9th, TYW closed at $11.08, a 7.74% discount to its $12.01 NAV.
The history of TYW’s market discount (which invited value-unlocking Activists) suggests that there may be a longer-lasting lack of a shareholder affinity for its strategy. TYW’s current approach of blending qualified dividends with municipal income is not something for which investors have showcased demand in a singular Closed-End Fund. TYW has generally been worth less than it Net Asset Value (“NAV”) since 2004. Like all Closed-End Funds, its initial public offering (“IPO”) early that year was at a premium to NAV. Generally, the average Closed-End Fund investor is less savvy that the advisory who earns a sales credit placing the IPO shares. It amazes me how frequently independent investors get “duped” in this space while trusting the posturing and financial advice of someone who’s motivations they do not fully understand.
The Activist in TYW is called Western Investment LLC. Its history includes not only unlocking shareholder value in such a manner as to equally benefit shareholders of all sizes, but such intrinsic governance proposals as the declassification of boards which are well recognized by proxy advisory firms. Western has already been credited for achievement in DHG, LBF, and DRP on the basis of Deutsche Bank’s DWS unit announcing near term liquidity events.
No Activist is successful every time and an Activism Profile piggyback thesis is always subject to anticipating probabilities of both the Activists' success, like-benefits to the ordinary shareholder, and timeliness. Dynamics in the TYW situation suggest that value is likely to be unlocked by an Activist, reasonably soon. The entrenched board’s power defense appears long in the tooth. Western’s proxy from year 1 among other Activist documentation is publicly visible and I have not noticed any entrenched announcement that the declassification proposal failed. Even a cursory assessment of rights and voting blocks’ suggests the writing may be on the wall.
Outcome Possibilities are Reasonably Favorable to Both Parties
A modest cash-tender or open-ending would be symbolic of the Advisor having no interest in ongoing shareholder captivity. Lacking an interest in captive assets under management, any fund’s board would be somewhat motivated to conduct buy backs and tender offers to restore shareholder value under the circumstance of long term discounted valuation of shareholder wealth. Here, insufficient market demand for TYW’s float at Net Asset Value has been seemingly reflected by a persistent discount in arrears of the IPO. A traditional liquidity event here is very much uncertain.
TYW’s Board seems to be in a somewhat fortunate position. QE2 suggests demand for focused Municipal Bond Closed-End Funds are likely to continue benefiting from favorable interest rate conditions for quite some time. Although I would not have purchased TYW for my account licensed to Covestor’s Tax Advantaged Income model absent an Activism thesis, I am likely keep a portion of my holdings there in arrears of the primary Activism thesis being graded by Mr. Market if TYW showcases good governance going forward. Among asset classes the masses perceive as highly conservative, Closed-End Muni Bond Funds may be uniquely positioned to present the realistic prospect of positive returns after factoring in real inflation and taxes in the wake of QE2. As noted in my Macro perspective, I expect negative real returns for “risk-free” assets for the intermediate term.
Disclosure: Long TYW, DHG, LBF, and DRP in accounts licensed to those Covestor Models cited in text. Short AOD in account licensed to Covestor’s Long/Short Opportunistic Model. Covestor is a Registered Investment Advisor (“RIA”) licensing Dan Plettner's data to create models for its clients. In addition to receiving royalties from Covestor, Dan receives income for securities research. Dan is neither a Registered Investment Advisor, nor an employee of Covestor.