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Long only, closed-end funds, deep value, long-term horizon
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Everyone knows that inefficient markets - like my favorite, closed end funds - sometimes offer unusual opportunities to those who follow the action closely. One of those opportunities seems to be facing investors now, in the current "transferable subscription rights" offer for Reaves Utility Income Fund (UTG), which closes August 8. Existing shareholders have been given one subscription right for each share they owned as of July 9. For every 3 rights you hold you will be able to buy 1 new share of UTG at a price of 95% of the LOWER of the average market price or average net asset value of UTG during the 5 trading days prior to August 8.

That means 3 subscription rights give you a discount on the price of the stock of at least 5%. I say "at least" because if the market value is above the net asset value (i.e. UTG is selling at a premium, as it sometimes does) your discount will be 5% below the net asset value, which itself is below the market price for a total discount of more than 5%. If the shares are selling at a discount to net asset value to begin with, then you will get another 5% off that already discounted market price.

Currently the stock sells at 25.46, so a 5% discount would be worth $1.27. But the rights themselves, which trade - for the next week or so - under the symbol UTGRT, are current selling at about 10 cents apiece. That means that for 30 cents you can buy 3 rights and that gives you the right to buy one share of UTG on August 8 at a discount currently worth $1.27 (i.e. ($25.46 X 5%).

Spending thirty cents to buy what is essentially a "coupon" that lets me save $1.27 per share on the stock looks pretty good to me.

But what's the catch? Supposedly there are no free lunches in the stock market or anywhere else, and that is true here too. My guess - and that's all it is - is that some holders of UTG who didn't want to go to the trouble of reading the prospectus and figuring out how rights offerings work, or who didn't have excess cash to use to exercise the rights, just dumped them on the market at whatever price they could get. And since there is a modest enough market for Reaves Utility Income Fund shares to begin with (122,000 shares traded today; respectable for a closed end fund, but still small compared to corporate stocks) there probably aren't a lot of people seeking to buy the rights to buy the stock.

For a pure arbitrageur who planned to buy the rights at a discount, exercise them to buy the stock at a 5% discount and immediately sell it to pocket the profit (which would be 5% minus what they paid for the rights), I would not recommend this trade. Closed end funds are too thinly traded and there is no assurance that you could get in and sell out fast enough before the price moved. But for long term holders of UTG, which is a terrific fund that holds high quality telecommunications, water, electric and gas utilities and provides a solid and growing 6% yield, being able to buy it at a 5% discount is a great opportunity.

For those who don't own UTG and didn't get rights distributed to them for free, or even for those who do own it and want to pick up some additional rights on the cheap, being able to buy those rights for a fraction of the value of the discount they entitle you to seems like a great opportunity.

Source: Reaves Utility Income - Great Fund Now On Sale At $1 Off