Why You Should Keep an Eye on the Special Opportunities Fund

Includes: FOF, GCE, PCEF, PIF, SPE
by: George Spritzer, CFA

In the current market, closed-end fund discounts are not nearly as attractive as they were in late 2008. I’ve been looking for special situations in closed-end funds with shareholder-friendly management that can provide good NAV performance. One CEF that is worth watching now is the Special Opportunities Fund, Inc (NYSE:SPE).

The history of this fund is quite interesting. From 1993 through 2009, the Insured Municipal Income Fund (PIF) invested exclusively in tax-free municipal securities. It was targeted by several CEF activist investors: Karpus, Western Investments (Art Lipson), RiverNorth Capital and Bulldog Investors (Phil Goldstein). After a proxy contest that ended in August 2009, a new Board of Directors was elected to manage the Fund.

The newly elected board elected to:

1) Replace UBS with Brooklyn Capital Management LLC (BCM), a newly formed advisor run by Phil Goldstein, Andrew Dakos and Steve Samuels.

2) Change the fund’s main investment objective from one of providing tax free income to one of providing total return.

These changes were approved by shareholders and the name of the fund was changed to Special Opportunities Fund to reflect its new objective and the opportunistic investment philosophy of BCM.

In September, 2009 the Board began a program to sell the Fund’s municipal bond portfolio in order to fund a self-tender offer for the Fund’s common shares. The purpose of the self-tender offer was to fulfill a commitment made during the proxy contest to allow shareholders the opportunity to realize the intrinsic value of their shares. BCM waived its management fee until the tender offer was completed, which occurred on January 22, 2010. All of the shares tendered (about 2/3 of the fund) were accepted for payment at a price of $14.18 (99.5% of the NAV per common share of $14.25).

After the tender, the Fund began its new life with net assets of $96 million in cash and cash equivalents. Since then, BCM has been looking for opportunistic investments in closed-end funds that it believes are undervalued and where they have an edge. The fund management expects it may take six months or more before they are fully invested. Currently, about 15-20% of the Fund is invested in accordance with the new objective and policies.

The closest competitors to SPE are:

  • Cohen and Steers Closed-End Opportunity (NYSE:FOF) : A closed-end fund that invests in other closed-end funds.
  • Powershares Income Composite Portfolio (NYSE:PCEF): An ETF whose portfolio consists of closed-end funds. Seeks to replicate the S-Network Composite Closed-End Fund Index.
  • Claymore CEF Index Goldman Sachs Connect ETN (NYSEARCA:GCE): An ETN that seeks to replicate the Claymore CEF Index.
  • RiverNorth Core Opportunity Fund (RNCOX): An open-end mutual fund with large holdings in closed-end funds.

But SPE differs somewhat from the above holdings, because it will put more emphasis on activist/opportunistic investing, and it may also invest outside of the closed-end fund universe. Management is also considering investments in auction rate securities available at a discount in the secondary market, merger arbitrage and viatical investments in life insurance notes.

The net asset value (NAV) of SPE is published weekly. On May 14, the NAV was 14.45. So the discount to NAV based on the May 14 closing price (13.07) is about 9.5%.

On May 14, FOF sold at a discount of 8.41%. GCE, PCEF and RNCOX trade at or close to NAV.

One potential negative for SPE is the high expense ratio listed on cefconnect of 1.76%. This is higher than FOF, GCE and PCEF, and similar to RNCOX. Since SPE is new, we won’t know the true expense ratio until the next few quarterly reports comes out.

One positive for SPE is company management. I respect Phil Goldstein and his team, who have a good reputation in the closed-end fund world as shareholder-friendly investment managers. They are well connected and experienced in closed-end fund activism.

There are at least two catalysts that could help the fund reduce its current discount to NAV:

1) The fund does not have a web site yet, but it is under development. Once the web site is completed, the fund should start to attract more investors which should help to shrink the discount.

2) The fund managers have produced good performance in their private account management. If they can produce good NAV performance with SPE, you would likely see a reduced discount to NAV and excellent fund performance.

Full Disclosure: Long a small “starter” position in SPE.