Hub fund managers unfreezing clients' cash
Investors in a growing number of closed-end mutual funds that were frozen by the credit crisis have been given the chance to reclaim their money by some fund families.
Closed-end mutual funds are among those hardest hit by the collapse since February of the markets for securities whose interest rates are set at periodic auctions. Without buyers, owners of these "auction-rate" instruments could not get their money.
But in recent weeks, Boston fund managers Eaton Vance Corp., Evergreen Investments, and John Hancock Funds have taken steps to make the funds liquid again, mostly by arranging new borrowing.
The steps put those three in a handful of fund complexes that have succeeded in freeing up investors' cash, said Cecilia Gondor, executive vice president of Thomas J. Herzfeld Advisors, a Miami financial adviser specializing in closed-end funds. She calculates that $15.8 billion of the $64 billion worth of auction-rate securities issued by all closed-end funds has been redeemed or will be soon.
For fund boards, the trick is to come up with a solution that benefits owners of both the common and preferred shares in the close-end funds, whose interests don't always match, she said. "The boards are doing a delicate balancing act," she said.
Unlike traditional mutual funds, closed-end mutual funds issue a set number of shares in an initial public offering, and these shares then trade on stock exchanges. In addition, many closed-end funds sell preferred shares to create "leverage," raising extra cash to buy more securities.
The preferred shares don't trade on public stock markets like common shares but rather in the auction markets that have frozen up in the credit crunch. Investors who can't find new buyers for the instruments receive a higher interest rate as compensation, but closed-end fund shareholders receive just an extra percentage point or so of interest, much less than holders of frozen securities issued by universities and other nonprofits.
One way out would be for the closed-end fund managers to buy back the preferred shares. But raising the money to do so could mean selling much of the underlying portfolio and reducing the value of the common shares, creating tensions between the two classes of stockholders.
The Boston fund companies have sought other remedies, mostly borrowing new money from outside banks to pay off preferred shareholders.
Since April 23, Eaton Vance has said its closed end funds have or will obtain financing to redeem about $3.3 billion worth of closed-end fund shares by today, of $5 billion total auction-rate securities that have had problems, spread across 29 closed-end funds.
In addition, on May 20 the Boston firm asked regulators to approve a new class of securities its closed-end funds could sell, known as "liquidity protected preferred" shares. To encourage new investors like money-market funds to buy the new instruments, at first Eaton Vance would take on the obligation of buying them back when auctions fail.
Jonathan Isaac, the company's head of product management, said the underlying securities are still sound.
For instance, one of the closed-end funds with preferred shares, Eaton Vance Insurance New York Municipal Bond Fund, invests in not-so-exotic instruments such as bonds issued by hospitals, the New York City Municipal Water Finance Authority, and the Triborough Bridge and Tunnel Authority. More than 90 percent of these carry ratings of AAA, according to the fund's most recent disclosure.
"It's not like anything has happened to the creditworthiness of the securities," Isaac said.
Meanwhile, Evergreen, the Boston funds unit of Charlotte, N.C., bank Wachovia Corp., said April 30 that three of its closed-end funds received financing from another bank it declined to name that will be used to redeem most of the auction-rate preferred shares. Though complex, the deal's advantage is that it balances the needs of all closed-end fund shareholders, said Scott Couto, Evergreen's head of global product development.
"The guiding principle was that we wanted to improve liquidity, but to do so in a way that didn't disadvantage the common shareholders," he said. The company is redeeming $694 million worth of preferred shares out of $970 million in total preferred shares in the funds.
Evergreen and other members of the fund industry's trade group also are asking the SEC to consider a temporary relaxation of a debt-coverage requirement to allow additional refinancing, he added.
Third is John Hancock Funds, the Boston investment business owned by Canada's Manulife Financial Corp. Since May 7 it has restructured about $1.7 billion worth of leverage in six of its seven closed-end funds that sell auction-rate securities. It is still studying how it might unwind preferred shares in its last fund, Income Securities Trust, which has $89 million in auction-rate notes outstanding.
Said Hancock Funds president Keith F. Hartstein: "We will not rest until we have effectively solved the illiquidity problem of all our leveraged closed-end funds in a manner consistent with the interests of both common and preferred shareholders."
Ross Kerber can be reached at kerber@globe.com.
