ETF Conversion – 10% Upside
A curious situation in the closed-end fund space. Several CEFs managed by First Trust Advisors, including FEI, FIF, FPL, and FEN, will convert into a joined-up ETF. These CEFs trade currently at c. 10% discounts to NAV whereas upon conversion this discount will be eliminated (as is the case with all ETFs).
These CEFs hold investments in publicly-listed MLPs and their NAVs are fully transparent. NAV exposure could be easily hedged by shorting a closely correlated MLP ETF, like JPMorgan Alerian MLP Index ETN (AMJ), which has exposure to a pretty similar portfolio of MLPs. Long-only positions would also capture an 8% dividend yield, but due to exposure to NAV volatility, this would be more of an opportunity to earn +10% above the MLP index rather than an arbitrage.
The conversion is expected to close in Q2 2024 and is subject to approval by shareholders of each fund. I expect this to pass easily, given the prospect of discount elimination. However, the quorum requirement is 1/3 of outstanding shares – given these CEFs are mostly held by retail investors getting one-third of them to vote might pose a risk (I do not have stats on what % of CEF shares usually vote on company matters).
But, there is always a ‘but’. The information is scant so far, only a press release which contained two strange clauses:
In connection with the proposed mergers of FEN, FEI and FPL into EIPI, each of these Target Funds may be required to recognize a decrease to its NAV prior to its merger, with another potential final adjustment to be made to the NAV of EIPI following the mergers after the receipt of year-end tax information to be provided by the master limited partnerships (“MLPs”) that had been held by such Target Funds. The amount and timing of such adjustments, if any, will depend in part on the market prices and composition of each such Target Fund’s portfolio securities.
As I have never dealt with CEF conversion into ETF and was not able to find any precedent transaction (CEF with MLP portfolio converting into ETF), I am not sure what these adjustments refer to nor how substantial they could be. The specifically indicated ‘decrease to its NAV’ is worrying when we have only a 10% gross spread on this trade.
After a bit of digging, I am tempted to think the anticipated adjustments are related to some MLP capital return tax nuances and will most likely be minimal. From FEN’s annual report:
Distributions received from the Fund’s investments in MLPs generally are comprised of return of capital and investment income. The Fund records estimated return of capital and investment income based on historical information available from each MLP. These estimates may subsequently be revised based on information received from the MLPs after their tax reporting periods are concluded.
Further details on these adjustments will be provided in the proxy materials which will be filed in the coming weeks. In the meantime, any additional insight on this from SSI members would be appreciated.
As expected, there are some issues with reaching the quorum. The shareholder meeting was adjourned to February 29 in order to “permit additional solicitation of shareholders and to allow shareholders additional time to vote”. FEI now trades at 8.4% discount to NAV. FEN is at 7%.
This one seems to be nearing the finish line. Shareholders of FEI, FIF, FPL, and FEN have approved the merger of these closed-end funds into a consolidated ETF. The transaction is expected to close by the end of April 2024.
The manager of these funds indicated that FEN’s NAV will likely remain unchanged, while NAVs of FEI and FPL will likely see minimal adjustments (increased by $0.03/share and decreased by $0.083/share respectively). There will also be additional adjustments related to taxes on MLPs, which are held by these CEFs. Any thoughts on these? I’m tempted to think these MLP tax related adjustments will be negligible. These funds continue to trade at 5-8% discounts to NAV. Upon conversion to ETF this gap will be eliminated. It seems the only uncertainty is risk of MLP taxes.
The transaction has successfully closed, and the combined ETF, now called FT Energy Income Partners Enhanced Income ETF (EIPI), trades at NAV.
This turned out to be a great play. I bought FEI FEN and FIF back in Decmeber. MLP’s in general have been doing very will for the past 8-10 months and I got about 20% appreciation plus dividends. I’m still holding EIPI but will probably sell soon.