Retail investors, non-professionals who buy funds and securities for their personal accounts, are playing an increasingly central role in the stock market, and the percentage of trading volume accounted for by retail investors is expected to grow to over 61 percent by 2030. However, these investors are now falling victim to activist investors.
Hedge funds are seizing on a loophole in an old law that allows them to hijack closed-end funds (CEFs), an investment especially popular with non-professional investors.
CEFs are critical to retail investors because they offer an opportunity to invest in private assets such as real estate, startups and private-equity funds. Those assets are usually only available to sophisticated and extremely wealthy investors.
Additionally, for many startups and other businesses, CEFs are crucial because they help those companies raise needed capital, particularly in times when venture capital and other sources of investment are drying up. CEFs help power the research, innovation and work that help various sectors improve society.
But activist hedge funds are increasingly targeting these CEFs, prioritizing short-term profits over long-term decisions. The attacks by hedge funds threaten to destroy the entire CEF asset class. If these hedge funds succeed, retail investors and the startups that rely on CEFs to raise capital will be on the losing side. Congress needs to step up to protect investors and the future of CEFs.
The most recent example is Saba Capital’s targeting of BlackRock’s CEFs. Saba is attacking 10 closed-end BlackRock funds, seeking to win control at three and have a minority slate at seven. Saba is the largest shareholder in each of the 10 BlackRock-managed Funds and the world’s single largest investor in CEFs.
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If they succeed in winning control of these funds, the hedge fund’s playbook is clear. They will try to force tender offers, conversions to open-end funds or to liquidate the fund altogether. While this method can provide a profit for the hedge fund, the hedge funds aren’t thinking about the effects on the retail investors.
Such attacks on CEFs have surged to a record high, and it has had a chilling effect on the whole industry. For the first time in more than a decade, there were no new CEFs opened in 2023, a sign of what’s to come if this pressure is allowed to continue. And unfortunately, the average middle-class investor – those that benefit the most from CEFs – will be the ones that suffer.
In contrast to open-end funds, closed-end funds have a fixed number of shares issued at the inception of the fund. Investors can trade their shares in the fund on an exchange, but the fund itself doesn’t issue or redeem new shares. That means the managers of the funds can make long-term investing decisions without worrying about the short-term concern of satisfying investor redemptions. Many CEFs also focus on providing a steady stream of income to its investors, typically by paying out the dividends from the assets held by the fund.
CEFs typically pay on a monthly or quarterly basis. This makes them appealing for investors that rely on fixed income, such as retirees. In 2023, 3.2 million US households held CEFs which returned about $16.3 billion to shareholders, with about 39 percent of these households being retirees.
For the future of CEFs, as well as retirees and businesses that depend on these funds for backing or income, we must do something about the dangerous loophole that has allowed for the attack on these funds.
The Increasing Investor Opportunities Act (IIOA), sponsored by Reps. Ann Wagner (MO-02) and Gregory Meeks (NY-05), would allow closed-end funds to invest assets more freely in securities issued by private funds and would remove the loophole that currently allows activist investors to force CEFs into liquidity events or radically change investment strategies. The House recently passed IIOA with bipartisan support, moving it to the Senate where they can hopefully pass it and move forward to protect millions of investors and the broader asset class.
Surging close-end fund activism is dangerous for more than just the shareholders. Though the activists claim their involvement will benefit long-term shareholders and lead to improvements in the fund’s market price, any improvement that is seen tends to be short-lived. Beyond harming investors, these takeovers could hurt the broader capital market since many startups rely on capital that comes from CEFs. These funds are one of the only ways for them to access capital from retail investors without listing on the public markets.
We need our elected officials in the Senate to step up and take care of this loophole once and for all. Now is the time to pass the Increasing Investor Opportunities Act and ensure activist hedge funds cannot continue to work against investors by hijacking CEFs.
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