EAD And EOD: Wells Fargo Sells Asset Management Business - The Opportunities?
Summary
- Here we go again! Wells Fargo recently announced the sale of its asset management business to GTCR and Reverence Capital.
- This is going to cause a new investment advisory agreement that would need to be voted on.
- We recently saw several other fund companies that are going through mergers or acquisitions provide us with some nice alpha opportunities.
- The best plays for this type of speculative trade are from EAD and EOD. Both funds are trading at larger discounts.
- I do much more than just articles at Yield Hunting: Alt Inc Opps: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
(This report was issued to members of Yield Hunting on Feb. 27.)
On Feb. 23, Wells Fargo (WFC) announced the sale of their asset management business to GTCR LLC and Reverence Capital Partners. Wells will remain the distribution partner and retain some client functions. They also will maintain a 9.9% equity stake into the new business.
This is very similar to other recent business sales as the industry continues to consolidate. We recently went through similar corporate actions most recently with Legg Mason/Western Assets' acquisition by Franklin Templeton. That one was a home run.
Here we will analyze the current setup and how we think best to play it. We like Wells Fargo Income Opportunities (NYSE:EAD) with its exposure to high yield bonds, moderate leverage, and stellar long-term track record.
What's Happening?
In the press release, they note:
Consummation of the transaction will result in the automatic termination of each fund’s investment advisory agreement and sub-advisory agreement(s). The funds’ Boards of Trustees (the Boards) will be asked to approve new investment advisory arrangements with the new company. If approved by the Boards, and to the extent required by applicable law, the new investment advisory arrangements with the new company will be presented to the shareholders of each fund for approval, and, if approved by shareholders, would take effect upon the closing of the transaction. The transaction is expected to close in the second half of 2021, subject to customary closing conditions.
Essentially, the board will vote to approve the new investment advisory agreement with GTCR/Reverence to manage the fund. They then will put the vote to the shareholders who will receive mail after mail and call after call pressing them to vote.
This is done on purpose. For one, the vote cannot be approved without a quorum, i.e. a certain percentage of share votes. Second, the solicitors who hound you to vote get paid when they eventually get you to vote. So they have an incentive to annoy you to the point where you just give up and vote.
If the vote is not approved, either because a majority of the shareholders vote against the action or because they cannot get enough people to actually vote, then something positive can happen for shareholders. So there's actually an incentive for shareholder NOT to vote the proxy or to vote against.
When Legg Mason was acquired by Franklin Templeton it triggered the same clause requiring a new investment advisory agreement. Western, owned by Legg, started sending out proxy statement to shareholders to solicit votes.
This piqued the interest of some activists who began swirling around and buying up shares. The largest activist in the CEF space already had positions in some of the Western Funds when the deal with Franklin was announced. So they just added to existing positions in EHI, HIX, and HIO among others.
The goal being to acquire enough shares, vote against the new advisor agreement and cause the fund to liquidate at NAV capturing the discount in the shares. Most of these funds were trading at double-digit discounts thanks to the COVID Crash so the upside potential was large.
After nearly a year of solicitations to get votes, they ended up coming to a deal with Franklin - called a standstill agreement. In the agreement, Saba agreed to vote FOR the new advisory agreement in exchange for Franklin conducting a tender offer for a portion of the shares. On two funds it was 50% of all shares and another 25%. Those tenders were done close to NAV.
The same thing could happen here. We could see activists jump in quickly and begin buying up shares to place a roadblock in the new agreement getting approved.
What's The Play?
Wells manages four closed-end funds amidst a broader array of asset management products including mutual funds, SMAs, defined contribution, and alternatives. The four CEFs account for a total of $1.6B in total assets. The entire unit has a total of $603B in assets under management and 450 investment professionals.
In the grand scheme of things, the assets held in their CEFs are crumbs under the table. It amounts to 0.26% of their total assets. How much time do you think they'll spend on attempting to get a quorum for those funds to keep managing them?
The total gross revenue is a mere $13.6M before any expenses. The rest of the business produces about $5.125B in revenue.
My assumption is that they spend little time defending these funds and that an outcome like we saw with Western where we had three generous tender offers and two funds fully liquidate (TLI and GFY) could occur.
Overview of the Funds
The four funds include one global equity fund, two taxable bond funds, and one hybrid fund that's focused on the utility/infrastructure space.
1- Wells Fargo Utility & High Inc (ERH): Premium of 5.4% and yield 6.72%
2- Wells Fargo Income Opp (EAD): Discount of -9.63% and yield 8.10%
3- Wells Fargo Multi-Sec Income (ERC): Discount of -4.5% and yield of 8.85%
4- Wells Fargo Global Dividend Opp (NYSE:EOD): Discount of -9.93% and yield of 9.90%.
The best plays for this type of speculative trade are from EAD and EOD. Both funds are trading at larger discounts. In the case of ERH, is at a premium so clearly no play there.
Top Choice: Wells Fargo Income Opp (EAD)
The fund is a high yield taxable bond fund (best for an IRA). The management of the fund is pretty strong with the fund ranking No. 4 out of 30 over the last three years for NAV total return and No. 2 out of 26 for the last five years.
The distribution has a managed distribution policy so the yield is not covered by the earnings in the fund. Coverage is 79% with UNII at -17.3 cents.
The portfolio is relatively higher quality of a "junk" fund with 44% in BB and 39% in B. Only 4% is in the junkiest category of CCC. The duration is a mere 3.37 years so interest rates do not have much effect on the NAV.
When analyzing these special situation alpha-generating trades we always want to be comfortable holding the underlying. That's because it will take some time for this to close. In the release, it stated the transaction is expected to close in the second half of 2021. That's at least five months away (minimum) so we have to want to hold the shares that long.
While we think HY is a bit rich overall, we don't advocate getting out completely. Most other high yield CEFs offer only marginal value or are expensive while this one is trading near fair value.
We will be adding EAD to our optional substitutes list with a buy under of -9.5%. More aggressive investors could buy closer to -9%.
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- YH Core Income Portfolio: yield ~8%
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Our team includes:
1) Alpha Gen Capital - I am a former financial advisor and investor. Not someone from another career doing this on the side. My analysis is meant to provide safe and actionable insight without the fluff or risky ideas of most other letters. My goal is to provide a relatively safer income stream with CEFs and mutual funds. We also help investors learn about investing and how to properly construct a portfolio.
2) George Spritzer - Another career financial guru who runs a registered investment advisor with a specialization in closed-end funds for individuals. George uses the following investment strategies:1) Opportunistic Closed-end fund investing: Buy CEFs at larger than normal discounts to NAV and sell them when the discounts narrow. 2) Exploit special situations: tender offers, fund terminations, fund activism, rights offerings etc.3) Landlord Investor- spent his career as a management consultant for public sector clients at a multinational consulting firm in the DC area. He has transitioned to a new career as a full time landlord. His investment portfolio is comprised of two parts -- broad-based index funds and income plays such as preferred stock, CEFs, and REITs. He also owns individual/baby bonds which he buys on margin to boost total return. Landlord is our 'individual preferred stock' expert analyst.
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Analyst’s Disclosure: I am/we are long EAD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (30)
7/15 added to ead near 9.5% discount ...
We'll need a new article, "Wells Asset Under New Management: What the Future Holds"
I also own ERC but it’s near NAV.
I voted No just to see what happens and to stop the constant phone calls.
