Last week, BlackRock filed to implement an at-the-market (ATM) shelf offering program for two of their funds: BlackRock Limited Duration Income (BLW) and BlackRock Floating Rate Strategies (FRA). Considering that both funds are currently trading at substantial discounts, this is a strange move.
ATM shelf offerings are similar to traditional rights offerings in that the fund files for the right to raise assets by issuing a certain number of new shares. With a shelf offering, the fund does not immediately issue shares onto the open market. Instead, it "shelves" the newly created shares and sells them on the open market at its leisure. However, funds are only allowed to issue new shares when they trade at a premium, as this is accretive to net asset value. Otherwise, the new issuance would be dilutive to current shareholders.
For example, consider a closed-end fund that has $100 million in net assets, 10 million outstanding shares, and trades at a 10% premium. With a NAV of $10 and a share price of $11, issuing 10,000 new shares raises $110,000 for the fund. However, each newly created share is issued with a NAV of $10. This means that net assets increase to $100,110,000, total outstanding shares increase to 10,010,000, and the NAV increases to $10.001. Shareholders just made a free $0.001 per share from the transaction. Alternatively, the same process would work in reverse if the fund trades at a discount. By issuing shares at a discount, net assets increase at a slower rate than the number of shares outstanding, which means that the NAV depreciates. Because of this, funds need shareholder approval to issue new shares at a discount.
Despite the potential for NAV accretion, many investors dislike ATM offerings for two main reasons. First, ATM offerings can lower share prices by eating into the fund's premium. While this may be true, it can ultimately be beneficial over the long run; premiums are often fleeting, and issuing new shares allows the fund to directly monetize positive investor sentiment. ATM offerings also give funds the flexibility to issue new shares over longer periods of time, which may not have as sharp an impact on share prices.
Second, many investors argue that raising new assets dilutes the assets currently in the fund. This is especially true for illiquid asset classes, where managers might not be able to find securities similar to what they currently hold in the portfolio. For more-liquid asset classes, this is less of a concern. Alternatively, if managers see attractive opportunities in the market, raising new assets can give them the opportunity to act on these observations without having to sell assets in the fund--this could create a taxable event.
Eaton Vance Tax-Advantaged Bond and Option (EXD) cut its quarterly distribution 17.7%, to $0.350 from $0.425 per share.
Federated Enhanced Treasury Income (FTT) cut its monthly distribution by 12.2%, to $0.043 from $0.049 per share.
Transamerica Income Shares (TAI) cut its monthly distribution 8.3% to $0.0825 per share from $0.0900 per share.
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Steven Pikelny does not own shares in any of the securities mentioned above.