Boaz’s Curious Lure of Fat Dividends

I have a love-hate relationship with Twitter. 95% of what I see is a waste of time, but figuratively speaking, 5% of what I see is highly valuable. Especially in the context of being a solo punter without a large team, budget, etc. The other day I came across someone mentioning ticker BRW as an interesting publicly traded closed-end fund and was surprised to discover that it is a Saba managed (Boaz Weinstein) fund. I wanted to write about it because the CEF world is rife with garbage management and unoriginal portfolio positioning. While I don’t own BRW (at time of writing), I believe it is one of the few CEFs that is actually original in its thinking and positioning.

Boaz

Weinstein is a well-known CDS trader/investor and has been banging the drum of late on tail risk opportunities via shorting B/BB cyclical credits funded by being long deeply investment grade names (and SPACs pre-merger). He also kept the lights on through a deeply boring credit period in the 2010s by running a closed-end fund activist strategy, buying CEFs at a discount. He agitates for change and aims to provide a return to investors via both dividends from the CEFs and closing the NAV gap. From what I see, Saba is the main player in this niche.

Making Your Mark

Enter Voya Prime Rate Trust, a CEF that Saba won over. Instead of forcing a liquidation, buyback, or other NAV closing event, Saba took over the investment management of the fund. In 2021, Weinstein outlined:

The ticker changed from PPR to BRW, and the name changed to Saba Capital Income and Opportunities Fund. It was a head-scratcher to understand how BRW relates to the fund name, and then I realized BRW is likely Boaz’s initials. Some people like monogramed shirts; others like CEFs.

Alas, Weinstein went on to make major changes to the fund immediately (emphasis is mine):

In connection with becoming investment advisor on June 4, 2021, Saba Capital broadened the Fund’s investment strategy from solely owning high‐yield loans to investing in high‐yield and investment grade bonds, SPACs, closed‐end funds and other investments…

…Saba Capital slashed the Fund’s 75% exposure to high‐yield loans rated single B or below because we believed a yield of 3 to 4% was insufficient reward for taking risks to companies with ‘junk’ ratings from Moody’s and S&P. In our view, the sales were also compelling because the Fund simultaneously bought a diversified pool of SPACs yielding 2 to 4%. As SPACs are only permitted to hold AAA rated U.S. Treasury Bills until they consummate a merger, the switch resulted in an increase in credit quality from junk to AAA with no loss of yield, while adding optionality for capital appreciation from successful SPAC acquisitions…

…the Fund lowered its leverage ratio from 28% to zero as of October 31, 2021. Saba Capital aims to utilize leverage in a more opportunistic manner…

BRW Annual Report

So the fund upgraded credit quality from B to AAA, lowered leverage to zero, and diversified the fund’s strategy set. Pretty good! It now seems to resemble more of a multi-strategy alternative fund versus a focused CEF. Furthermore, by reducing leverage to zero, it loosens the straitjacket most CEFs sit in. Namely, they are fully leveraged at all times, forcing them to sell at the worst of times and buy at the best of times. As such, it can increase leverage opportunistically when spreads widen and capital is short.

BRW Early Results

By April of 2022, it showed good returns versus most standard benchmarks:

Weinstein had a very short note in BRW’s April 2022 shareholder letter, but he indicated:

Consistent with the Fund’s goals of delivering a high level of current income and capital appreciation, shareholders should expect to see increased portfolio exposure to high‐yield bonds/loans and equities, and decreased exposure to SPACs, now that valuations have become more balanced.

BRW Semi Annual Report

Leverage has gone up from zero (Oct-21) to ~38% (Sep-22) as the market has deteriorated, principally from adding exposure in corporate bonds and equities, along with more SPACs and CEFs.

Asset	% of Equity Base
SPACs	94%
Corporate Bonds	15%
CEFs	14%
Equities	7%
Senior Loans	3%
ST Investments	1%
Sovereign Debt (Ukraine)	1%
Rights / Warrants	0.5%
Unit Trusts (Bitcoin)	0.5%
Pref Stock	0.5%
Other	1.5%
Liabilities / Debt	(38%)
CDS / Contingent Fwd Contracts	N/A

I think it’s fairly clear why BRW is a bit different than most others in the sleepy backwaters of CEFs. But to return to the title of this post, the dividend is where this gets more interesting intellectually.

That ‘Phat Divvy

In Boaz’s first letter, he outlines:

…the annualized distribution rate was 4.5%. In July, the Fund implemented a managed distribution plan of 8% per annum, which was increased to 12% per annum on December 20, 2021.

Whoa. That is quite a change in payout. Is this fund invested in CLO equity with leverage as a cherry on top?

Boaz explained the reasoning for the high dividend:

In an effort to reduce the discount between the Fund’s share price and its NAV, the Fund’s Board of Trustees recently announced an increase in the managed distribution from an annual fixed rate of 8% to an annual fixed rate of 12%. This significant increase will position the Fund amongst the highest yielding CEFs. Our internal study of premiums/discounts and NAV yields displayed a strong correlation. Of 33 CEFs with NAV yields of 10% or greater, the median premium to NAV was 5% or more, with only two trading at discounts greater than one percent.

As I indicated above, CEFs don’t offer a ton of degrees of freedom, especially if one is fully leveraged. REITs and BDCs share some similarities in that respect. CEFs, REITs, and BDCs have great access to capital when markets are liquid and the public loves the entity (read: pushes it above NAV or reasonable fair value). If a CEF trades below NAV, it effectively is capital constrained if it is maxed out on leverage.

As such, Boaz, ever the self-described puzzle aficionado (listen to any podcast with him), is playing a game of luring high dividend-seeking investors to enable access to capital at NAV or above. Why pay a dividend in line with earnings if it results in below NAV trading performance?

Look no further than CLO equity CEFs to see how high dividends, irrespective of whether they are a return of capital or income, can trade vs NAV. Eagle Point Credit is a leveraged CLO equity CEF with a distribution yield in the mid-teens:

As such, Boaz is intentionally looking to return capital to investors (in addition to the income) with the hope that BRW trades at a premium and that the pipeline to issue more equity semi-permanently opens. Alas, success has not been found as BRW trades at a discount to NAV:

Time will tell whether this strategy of piecing together the retail “bees to honey” gravitational pull to high dividends counters some of the limitations of publicly traded closed-end funds. At the very least, it is an interesting way to approach the game.