Forget Sunday’s World Cup final between Argentina and France. The real nailbiter is the current closed-end fund smackdown between Franklin Templeton and Saba Capital Management.
Franklin Templeton is striking back hard at Saba by issuing mountains of new preferred stock in three closed end funds that Saba is targeting in an activist proxy campaign. The new preferred shares have special board voting rights and effectively dilute the voting power of the funds’ common stockholders, including Saba — thereby entrenching management.
The three funds are ClearBridge MLP & Midstream Total Return Fund, Energy Midstream Opportunity Fund, and MLP & Midstream Fund — all of which invest in oil and gas pipeline master limited partnerships and came under Franklin’s purview when it purchased Legg Mason in July 2020.
The funds recently traded at discounts to their net asset values of between 15.12 percent and 17.84 percent, according to Morningstar. Saba, founded by credit whiz Boaz Weinstein, owned positions in each of the three funds ranging from 6.18 percent to 14.62 percent. In late October the firm launched a campaign for board seats at each of the funds.
Saba’s game plan is to force the funds’ boards to narrow their discounts by tendering for shares at above market prices, merging the funds with a similar open-end offering, or simply liquidating the funds. Doing so in this case would likely generate immediate gains for the funds’ long-suffering shareholders — and Saba.
The three Franklin funds are poor performers, having trailed their benchmarks over the three-, five- and 10-years ended November 30, according to Morningstar. In 2020, they each lost 60 percent or more, partly due to unwise and excessive leverage. And the three funds charge adjusted expenses of between 2.75 percent and 3.03 percent, according to Morningstar.
“The funds, held mostly by retail shareholders, have suffered over $500 million of underperformance [during the past five years],” wrote Saba partner Paul Kazarian, who runs the firm’s closed end fund arbitrage business, in an email.
In addition to hedge funds, Saba also runs a small ETF that invests in closed end funds as well as its own closed end offering.
Spokespersons for Franklin Templeton did not comment on the record for this article.
The new preferred stock — technically mandatory redeemable preferred stock — gives holders the right to elect two directors to each of the funds’ boards. Terms vary depending on the particular fund and share series, but at ClearBridge MLP and Midstream Total Return Fund, the series D preferred shares, yielding 4.26 percent, have voting power equal to about 283,333 common shares, according to a Securities and Exchange Commission filing. The same fund’s series E preferreds have voting power of 366,667 common share equivalents — the amount Prudential Financial disclosed holding in its own agency filing, without specifying the preferred series.
Added together, the voting power of new preferred stock is worth 650,000 shares. Saba, by comparison, holds 703,883 shares in the fund, which is equivalent to 10.05 percent of the common outstanding.
The ClearBridge MLP and Midstream Total Return Fund preferreds were issued in a private placement and the SEC filing does not disclose the current holders. It’s clear, however, that they have the potential to gum up Saba’s proxy campaign.
“ClearBridge and the board appear desperate to avoid being held accountable,” Saba’s Kazarian said.
Franklin’s entrenchment efforts are troubling to some experts aside from Saba.
“Tactics that ultimately result in less shareholder protection and rights do not bode well for the future of markets,” wrote Luis Viceira, a finance professor at Harvard Business School who follows Saba, in an email. “If management has a good case to explain the performance of the funds and for what they are doing, or a case for why liquidating or opening the fund might hurt existing shareholders versus continuing as they currently are, they should make the case with them and win them over, not hinder their rights.”
At the other two ClearBridge funds, SEC filings identify both Prudential and American International Group as holders of various preferred share classes, though the terms of these are not disclosed in the filings.
Whether the directors elected by these insurers or other preferred shareholders will support Saba efforts or side with management is something of an open question.
A legal note by Foley & Lardner LLP partners Gardner Davis and Danielle Whitley cites a Delaware Chancery Court ruling that directors, even if elected by preferred stockholders, have a fiduciary duty exclusively to common shareholders. So such board members may be obligated to support Saba’s efforts, or risk accusations of violating their fiduciary duties.
Prudential did not return an email seeking comment. An AIG spokesperson declined to comment.
Saba, which had $4.8 billion in assets under management as of November, is otherwise having a knockout year. The firm’s flagship Saba Master Fund returned 25 percent year to date through October, according to media reports, versus a loss of 4.45 percent for the HFRI Fund Weighted Composite Index.
Saba benefited by writing credit default swaps on strong credits like Walt Disney and PepsiCo while buying them on more volatile or cyclical company bonds, according to media reports.
