If we don’t act fast, 2024 could be a financially unstable year for retirees. With Social Security payouts expected to increase much less than last year due to a lower cost-of-living adjustment, activist investors on Wall Street are poised to increase their activity. This is bad news, particularly for Virginia retirees who may fall victim to activist investors’ lucrative exploitation of closed-end funds (CEFs) — a type of fund similar to a mutual fund that is traditionally an important source of distribution income for seniors.
By taking advantage of a regulatory loophole within the Investment Company Act of 1940, billionaire investors will continue in 2024 to follow a strategy that not only undermines the stability of CEFs, but also jeopardizes the retirement savings of thousands of Virginians if Congress doesn’t act quickly and pass the Increasing Investor Opportunity Act.
The scheme of these activist investors involves identifying CEFs trading at a discount to their net asset value, meaning the cost per share of the CEF is lower than the cumulative value of the underlying holdings that make up the fund. Next, by leveraging this perceived vulnerability of these CEFs, wealthy investing groups initiate a hostile takeover by acquiring considerable shares and becoming a majority owner, thus allowing them to reshape the board to favor their own financial interests. Finally, these newly appointed boards then hand over management contracts to the same hedge fund managers. This often leads to a shift in investment strategies from high-quality, reliable senior loans to riskier assets such as cryptocurrencies and special purpose acquisition companies, shell companies created solely to raise capital through an initial public offering for the purpose of acquiring or merging with an existing company.
Thanks in part to the increasing activist onslaught, CEFs are already dwindling in numbers. The activists’ influence in these funds inevitably results in changes to the investment strategy, putting retirees’ savings at risk by introducing volatile assets that deviate from what retirees expected to be a steady stream of distribution income. The shift in focus towards riskier assets not only jeopardizes the financial security of retirees, but also exposes them to potential losses, which is not what retirees signed up for when they originally invested in these funds.
While activist investors may argue that they are taking over the fund for the better, the results prove they are only in it for the profits. They continue to ignore the fundamental principles outlined in the Investment Company Act of 1940, which has long served as a safeguard, preventing hedge fund billionaires from exploiting the types of funds everyday Americans invest in for their own gain. Moreover, it emphasizes the fiduciary responsibility of fund boards to act in the best interest of all investors, not just those nominated by deep-pocketed activist investors.
We need to protect retirees, the primary victims, and demand swift action from Congress. As a member of the Senate Banking Committee, this is an opportunity for Sen. Mark Warner, D-Virginia, to help protect consumers by supporting a Senate companion bill to the Increasing Investor Opportunities Act. This bipartisan bill would help level the playing field for everyday investors by imposing a 10% cap on hedge funds’ holdings of a CEF, preventing activists from securing a controlling interest in a CEF. It would also help ensure that retail investors using CEFs to save for their long-run financial goals can do so without worry of being derailed by professional, short-term traders.
The Increasing Investor Opportunity Act is essential for safeguarding Virginia’s retirees from the negative financial impacts of activist interventions. Urgent action is required from Warner and Congress to address this pressing issue and protect the livelihoods of those who have contributed to Virginia’s long term continued growth.
Robert Kaltenschnee of Yorktown is a product specialist at Truist Wealth who has spent 15 years in wealth management.
