How do closed-end funds(CEFs) value convertible preferred shares the fund has ISSUED when calculating NAV? If the shares of the convertibile preferreds are valued at face value and the price of the shares of the fund have appreciated significantly, there is a significant liability not reflected in the NAV which just seems a little sketchy. Buyer beware I guess. I have noticed when a couple of CEFs announced the redemption of “in-the-money” convertible preferreds, the fund’s price has taken a hit in the market which leads me to believe maybe the existence of such liability is a surprise to some issue holders and the value over par is not accounted for in the NAV. Or maybe the price decline is a result of preferred holders shorting the CEF to protect their gains BUT the two events I have followed, the price decline of the fund was similar in value to the “surprise” liability, which leads me to believe the former is the case. Any thoughts? Anybody with CEF accounting experience?
Bumped just in case there is new blood with some expertise.
Why would the preferred be valued at face if they are in-the-money?
I’d assume it has to do more the valuation of an equity position in-lui of a perpetual dividend. The market is probably valuing the preferred more than the equity.
Certainly sound dilutive to common shareholders. If they redeem/covert them, the share count should rise and assuming the discount/premium is still warranted I would assume the market price would adjust downward like you suggest. Depending on the asset class that the CEF invests in, it could be a largely retail shareholder bas who could easily overlook such details.
Could we get specifics on the Closed End Fund convertible shares in question? Perhaps the original poster is long gone.
Sometimes, the CEF will issue preferred shares as a form of borrowing to leverage the fund after it is initially launched. If so, it is not dilutive. Assuming the leverage is used with a net gain over the cost of the leverage.
Or, are we talking about original common shares which are convertible?
Here’s the issue that caused my original post. The reported NAV did end up being reduced dramatically overnight, obviously, and the discount widened substantially. A double whammy. Just doesn’t seem right to keep valuing a liability, level one at that, at par when you are on the hook for a much higher value. SPE is issuing more convertible preferred at the moment, which reminded me that I still don’t know what the accounting rules require. I’m leaning towards SPE having done it correctly, reputable management. Just seems whacked. I recognized the issue, but John Q public got screwed. SPE did try to communicate the issue through annual and semi-annual reports, but shouldn’t NAV be NAV… https://www.thestreet.com/story/12492326/1/special-opportunities-fund-announces-final-results-of-redemption-of-convertible-preferred-stock.html
Thanks for sharing this. With CEF’s, NAV is not what the shares trade at (as you know).
Interesting that one of SPE’s investment objectives is to find CEF’s that trade at undervalued discounts to NAV.
They have had several share buy backs in the past 1.5 years, so perhaps they are trying to protect the investors from abnormally large discounts to NAV? However, with the new preferred issuance, there is definitely some deja vu. I will go through their most recent financial reports (it is a 40act fund, so they have to report in pretty granular detail) over the weekend.