Section 18 of Investment Company Act of 1940

I note many questions, comments etc on coverage ratios of closed end funds (CEFs).

I am in the office for only minutes but am posting Sec 18 here at this link–

Capital Structure of Investment Companies

This lays out dates etc relative to coverage ratios–and what happens if the company break coverage rules.

Practically speaking – I wrote on how this was handled back in 2009, 2010 and 2011 by the Gabelli companies on Seeking Alpha.

The article is here–but the links are old and no longer work.

45 thoughts on “Section 18 of Investment Company Act of 1940”

  1. Tim,
    Most of CEF preferred shares held privately. When they issued is there requirement for SEC filing? i am guessing there is no requirement. So CEF can increase leverage without disclosing it shareholders.

  2. We are witness to a relatively rare event, that being closed end funds selling to maintain coverage ratios. Clearly, closed end selling has added to the downward price pressure.

    ETFs and open ended funds have to sell when they have redemption, and I’d be pretty sure they have had plenty.

    CEFs don’t have to sell for redemptions.

    1. That isn’t how ETFs work. The funds themselves don’t typically do trading. Authorized participants do in kind creation and redemption and that usually only happens when there is an opportunity to make a spread between the etf and its underlying assets.

      This is the reason there are so many dislocations between the ETFs and their NAVs because the AP’s aren’t willing to keep them inline. ETFs can trade hands all day long without a single creation or redemption taking place

      1. Thanks. I did not realize ETF operated as such. Who or what is the Authorized Participant? Is this public information for the ETF? Really Appreciate this explanation

          1. all broker dealers are AP with etfs. they all get some revenue from lendings ETF, some revenues go back to ETF and offset management fee. etf assets are held by custodians. all this is complicated and who knows if some etfs represent real assets

            1. No, not all. They have to apply and register with each issuer. It isn’t that complicated.

              1. I had read a while back that when etf’s were created the sage of
                Ohmaha said not to invest in them. I don’t remember the reason. Does it have to do with not really knowing what assets they hold?

  3. I haven’t committed new capital yet but I’ve taken advantage of this calamity to upgrade my holdings quality and book some capital losses. I’ve sold several BDCs and redeployed the funds to buy the top dog in the group MAIN; sold various equity CEFs and redeployed the funds in UTF and ASG; similar with REITs sold most and added to STOR, and bought WPC and MPW.

    I am doing the same with preferred but so far the top quality ones (ie Tim holdings) are not coming down enough 🙂

    1. Jayr – I keep going back and forth between UTF and UTG. How would you decide between the two. I am having the same problem between RQI, RIF and RNP.

      UTG has a smaller dividend / discount but has lower leverage, somewhat better price performance and a 5 Star Morningstar rating…

      Sure would appreciate a few of the finer points in selecting a CEF when it is a close call. What do you consider to be Tim’s top holdings. Don’t know where he posts that?

      1. Mark, aside from the metrics you mentioned I look at total return to choose among similar CEFs. Both UTG and UTF are solid CEFs and I’ve held both at one point or another, though I think UTF is now more deeply discounted.

        I’ve owned a sizable amount of RQI for several years and very pleased with its performance I am also planning to add more. RQI and RNP have fairly similar top holdings and almost identical total return. RIF holdings are identical to RQI but doesn’t use leverage so its total return lacks the other two. All are good holdings so it’s really a matter of choice of being exposed to leverage or not.

        As for Tim’s holdings mostly the preferred and baby bonds he shared in various posts/comments, e.g. shares of Gabelli funds, some of the utilities like NEE-N, ENO, NI-B, and Duke energy among others. 

        GL with your investing. 

        1. Thanks JayR as a follow up I wish to introduce myself and share my point of view. I have been generally inactive in the markets since hitting a couple of home runs with very distressed MReit preferred shares during the subprime crisis (I bought too soon and suffered a lot of stress). I am very appreciative to Tim and the members of this site for the fantastic information and comments.

          As a follow up, I wish to advise caution as I have seen this movie before. A lot of the tone on this board is wow getting great deals. I too am anxious to lock in yield because CD and money market rates are now insufficient. Been doing extensive research on CEF Preferred, Fixed to Float Preferred, Baby Bonds, and CEF securities. I have been waiting for another set up like this for a decade.

          My working hypothesis is that this one is likely to end up being worse than the 40% SPX subprime drop. That crises lasted 12 weeks from top to bottom. That drop can be characterized as an initial period of uncertainty (panic) and then 2 quarters of earnings call guidance before we hit bottom. Once this virus runs it course, we are going to get hit with extraordinary financial fallout, a big name (someone like Boeing) is going to go bankrupt (remember Countrywide). I also suspect unemployment is going to be shocking and we will see a host of other problems… My working hypothesis is at some point we will get some consolidation (four weeks last time) and then another leg down. I believe we are in the early innings of what is going to be a slew of dividend cuts, restructurings…. I look forward to participating as this a far better group than Seeking Alpha or the old Yahoo board. Thanks again for your assistance.

        2. Gamco natural resources preferred is $5.00 under par. GNT-A. this is trading like they blew the coverage ratio.

  4. Liquidity (lack thereof) in these preferreds has definitely caused price suppression it seems. My regular stocks rose huge today but generally the preferreds still pulled back a bit…anyone else seeing this?

    1. Yazzer,
      I agree. My commons kicked butt today – some like D were up ~20% or more. The fixed income side was a totally different story. The fixed to floating issues (also non-cumulative) continue to get obliterated.

      Fixed to floating securities – at least in the US, are something I urge everyone to strongly do some due diligence on because the game has drastically changed. For so many issues, the FtF ‘penalties’ at first call are no longer going to put lots of pressure on them to be called.

      Personally, as I can, I’ll be liquidating most FtF issues that are non-cumulative.

      2WR and I were having this discussion earlier offline. I thank him for awakening my senses that were otherwise dizzy from yesterday’s smackdown on the common side.

      1. @Aff

        Thanks for the reply. I do not have any non-cum stuff except for two banks which are not doing too bad considering. Maybe the FTF bogie is impacting even the cum issues? I think liquidity is an issue as well…with people getting liquidated, they are forced to sell no matter what. Stocks can recover from that since they are more liquid but the preferreds get bid downward and take more time to bottom and then to recover?

    2. Yazzer – Yes. Tim could you please share your experienced insights on this? Several of my UTE notes and preferreds went down today or remain near their lows while the common went sharply double digit up — for example Southern (SO), Sempra… My plans are to hold onto all of them, I view all of this as a learning curve and value very much the experience regarding preferreds of those much more experience than me.

    1. Gaslog Partners A-B-C preferreds did not make the March 16, dividend payment. Does anyone know if they will be paying anytime soon?

        1. SunnyFlorida & dlcnws — Thanks for you reply. The payments were just posted to my accounts, although a day late.

    1. Jonathan–as you know they (BDCs) can be at 150% on asset coverage now.

      But Yes they are covered under the 1940 act–but under a different section from 1980—section 54 and further sections 55 to 65. I’ll see if I can get the data later on today for posting.

      The primary difference (to me anyway) is that BDCs have mostly level 3 debt and equity on the books–this stuff has no trading market and is valued by the company.

      The Gabelli CEFs and other have level 1 assets–mostly common stock that the value is directly observable–so you don’t have to count on the company to tell you what it is worth–you can simply look it up.

        1. ES–most preferred are optionally redeemable (callable) by the company 5 years after the original issuance. Some are longer some are shorter–but most are about 5 years.

          The company has the OPTION to call at $25 plus accrued dividends (or interest if a baby bond)–but they are not required to call it.

          We list the time it first becomes callable on all the spreadsheets and on each individual security page.

          1. does it make any difference to call preferred if it trades at 30 or 25? Assuming 1st call date passed

  5. What on earth is happening to the m-reits and their preferred’s? I know a lot of stuff is getting liquidated but come on.

    1. Tech Guy
      I saw on another board that UBS is liquidating their ETRACS 2X funds including reits, bdcs, and mlps

      1. Good reason not to buy such funds. When they liquidate a position they drive the price down and continue to sell at a bad price.
        If that’s the main problem then these should be bargains. I’m not buying more REIT preferreds yet but definitely not selling what I have .

      2. Live by the sword…
        A couple of surprises in this list.

        ” US High Dividend Low Volatility ETN”
        Low volatility? Guess again…

        MLP Ex-Energy ETN
        Ex-energy? If they exclude pipelines, that list is in single digits now, with issuers like Landmark and Compass.

        UBS announces mandatory redemption of ETRACS Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN due June 24, 2044
        Tue, Mar 17
        UBS announces mandatory redemption of ETRACS Monthly Pay 2xLeveraged US High Dividend Low Volatility ETN due September 30, 2044
        Tue, Mar 17
        UBS announces mandatory redemption of ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN due October 16, 2042 and ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN Series B due October 16, 2042
        Tue, Mar 17
        UBS announces mandatory redemption of 2×Leveraged Long ETRACS Linked to the Wells Fargo® Business Development Company Index due May 24, 2041 and 2×Leveraged Long ETRACS Wells Fargo® Business Development Company Index ETN Series B due May 24, 2041
        Tue, Mar 17
        UBS announces mandatory redemption of ETRACS 2xMonthly Leveraged S&P MLP Index ETN Series B due February 12, 2046
        Fri, Mar 13
        UBS announces mandatory redemption of ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN due March 13, 2045
        Fri, Mar 13
        UBS announces mandatory redemption of ETRACS Monthly Pay 2xLeveraged US Small Cap High Dividend ETN due February 6, 2045
        Fri, Mar 13
        UBS announces mandatory redemption of ETRACS 2xMonthly Leveraged Alerian MLP Infrastructure Index ETN Series B due February 12, 2046

        1. Wow–justin–very dangerous–we have been down this road before–years ago we went through liquidations–of course short memories were advocating these.

        1. Hi Tim and All, This is a rudimentary question but where is the best place to find the current actually “cash on hand” coverage percentage of any CEF? How does one go about looking this up? For example if I wanted to look up the Liberty CEF “USA”. Your table of this for the CEF’s you track has been so helpful– thank you so much for it!

        1. Earlybird,
          I belong to a service where it was posted. Basically the same info as Justin posted above.

        1. Tech,
          They are obviously not good investments and are actually notes designed to track an index. They are not required to own any of the issues in the index they track so when they liquidate they are not necessarily selling the underlying index.

          1. Not technically, but the issuers tend to own swaps or some other mechanism to hedge it, which does need to get unwound.

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