The Closed End Fund ETF Quietly Returning 15% While Yielding More Than Most Bonds

Closed-End Funds (CEF) and Exchange Traded Funds (ETF) are both investment pools that trade on major US stock exchanges, and focus on very specific financial topics, such as high dividend yields, technology, real estate, energy, international markets, and a large panoply of other sectors. Nevertheless, there are a few differences between them, such as:

• ETFs are most often passively managed and track a designated index, whereas CEFs are inevitably actively managed and subject to a portfolio manager;s discretion.
• ETFs use derivatives, such as covered call options, as a first choice tool for generating dividend income CEFs and their managers tend to favor using margin leverage to enhance gains and income.
• ETFs have a variable number of shares, similar to open-end mutual funds, whereas CEFs have a fixed number of shares. 
• ETFs trade relatively close to their Net Asset Values (NAV), whereas CEFs may trade at a premium or discount to NAV. 

Sabra Capital Management’s Sabra Closed-End Funds ETF (CBOE: CEFS) is the odd duck – an ETF that invests in CEFs. However, it has a specific goal in mind: to capture the arbitrage opportunities when a CEF trades at a discount to its NAV. 

Closed-End Fund Arbitrage With NAV

Net Asset Value is a sometimes overlooked metric with funds. Essentially, NAV is the total value of a fund minus its liabilities, then divided by the total number of shares. Due to their fixed number of shares, CEFs can sometimes trade at a discount to their underlying NAV. Eagle-eyed investors who see these discrepancies can avail themselves of an arbitrage opportunity – effectively buying assets at $0.85-$0.94 cents on the dollar. This intrinsic value can pay off in a trade scenario if the CEF wanders into overpricing territory due to a surge of buyer enthusiasm, or can be a locked-in profit if one wishes to continue to ride a bullish trend. 

The entire strategy of CEFS the ETF is to search for and take advantage of these arbitrage opportunities. Launched on 3-21-2017, CEFS details at a glance are as follows, based on market at the time of this writing:

Activism For Fair Value and Profit

Sabra’s combination of savvy CEF discount to NAV acquisition process and proxy battle acivism to compel boards to close the NAV gap is unique on Wall Street.

While it’s true that many investors may recognize NAV arbitrage buying opportunities and take advantage of them, there is usually little they can do about it until the market recognizes the discrepancy and closes the gap. Sabra Capital Management’s two-pronged approach is to:

1. Identify and acquire large share stakes in undervalued CEFs. 
2. Sabra then uses its financial clout, SEC legal savvy and shareholder bloc to initiate structural and operational changes in the company via a proxy battle with its board to close the NAV gap. These changes may include:

• Commence share buybacks at NAV price;
• Force a format conversion to open-end mutual fund or ETF;
• Liquidate underperforming or nonperforming assets on the books.

With its 6% yield and 15% YTD return, many investors might think the Sabra approach to be an attractively novel one. There are two caveats that they should bear in mind:

• CEFS carries a hefty 2.61% expense ratio. While the management fee is 1.10%, the proxy battles and lobbying activities are capital intensive for legal and accounting fees. 
• Average daily volume is under 100,00 daily shares, so liquidity may be an issue for some investors. 

CEO Boaz Weinstein has made the activist approach a core strategy of Sabra Capital Management, and has also applied it to BDCs, REITs and SPACs. CEFS is the kind of ETF that appeals to investors who enjoy the discount advantage and like the idea of seeing the discount close and their gains appear, literally in real time.