Last week I speculated about the possibility of Abrdn Property Income (API) shareholders opting to continue as a real estate investment trust rather than proceeding with a managed wind-down after its proposed merger with Custodian Property Income (CREI) failed to attract sufficient shareholder support.

That got me thinking about other similar situations. One that is topical is debt fund GCP Asset Backed Income (GABI ).

GABI’s future has been up in the air since last summer. Like many investment companies, its fortunes have been somewhat tied to the direction of interest rates, as rising rates made its yield look relatively less attractive when compared with yields on ‘risk-free’ assets government bonds and cash deposits. In addition, signs of recession led to fears of defaults given there were already some problem loans in the portfolio that have depressed returns in recent years.

With all of this going on, it has been easy to forget that GABI was still growing net asset value each year and was still a decent size at more than £400m. In fact, a year ago, the board seemed quite excited about the fund’s prospects.

As older lower-yielding loans matured, they were being replaced by loans offering a better risk/reward profile. The fund managers were making new loans offering returns of about 8.6% on average and said that they had an attractive pipeline of potential investments. Institutional investors were also taking more of an active interest in the sector, they reported.

However, the shares traded on a persistent discount and in August 2023, GABI announced that it was considering a merger with stablemate GCP Infrastructure (GCP ). It seemed a reasonable fit and there were obvious attractions for both parties to the deal. Both had seen persistent discounts open up as interest rates had risen and combining them into a larger vehicle would have improved liquidity for all shareholders and improved efficiency for all by stripping out one set of fixed costs.

However, a significant minority of GABI shareholders were unconvinced, fearing that GCP’s risk profile and portfolio duration were quite a bit different to what was on offer from GABI. On 18 September, GABI said the merger was off and that it would hold a continuation vote in May.

‘Minority’ was an interesting word here as it suggested a majority of GABI investors would have wanted to remain invested in the bigger fund. It got me thinking that maybe they would still rather hang on to a yield of more than 9% from a fund of this type, whether it was in GCP or GABI, rather than cash in and look for an alternative.

However, on 14 March GABI’s board said that it had talked to shareholders holding a majority of the voting rights. While a minority of shareholders did want the fund to continue, the board felt that if the others exited, it would shrink the company so it would no longer be of a viable size.

What is a viable minimum size for a fund like this? As you know, I have serious reservations about the giant wealth managers’ calls for ever larger funds. I heard recently that one leading wealth manager now says it might not consider anything with a market value below £1bn. I think the result of this will be that its clients miss out on a lot of opportunities in smaller funds and end up with returns closer to the market.

Staff and investors who are uncomfortable with this are already heading towards smaller wealth managers or are going it alone. DIY investors are an increasingly important proportion of share registers. I think that a fund such as GABI could operate reasonably well with assets of £150m–£200m.

Nevertheless, the GABI board has decided that shareholder value would be best served by a proposed orderly realisation and return of capital. This is what shareholders will now be voting on at the AGM next month.

The loans in the portfolio have a range of maturities, with more than £110m maturing in 2030 or beyond, and more than £75m maturing between end 2025 and December 2029. There ought to be secondary market demand for most of them, but this was not a portfolio that was put together with this scenario in mind. A managed wind-down could take a few years and a lot could happen in that time.

With inflation receding and some commentators suggesting that it could be at or even below its 2% target in 2025, I am wondering how long it will take before investment company investors’ sentiment catches up with the institutional investors believing the sector has started to look interesting. I think there is a risk that we could get a couple of years into the wind-down process and find that investment company investors are considering backing the flotation of a similar fund.

There is an alternative to a managed wind-down and that is to use tender offers to remove those investors that want an exit. The first of these, funded by the £55m cash pile the fund had, could happen immediately. Then, if sentiment shifts, the tenders can stop and eventually the fund can re-expand. This could be a better outcome for all.

With all of the turbulence that markets have suffered over the past few years, it is easy to forget that closed-end funds are supposed to sail above this as long-term investment vehicles. Yes, boards should be cognisant of discounts where these emerge and take reasonable steps to manage them. However, that should not mean effectively open-ending any listed fund that falls out of favour.

One of the key advantages of the closed-end structure is that they can take contrarian views and take advantage of forced selling from open-ended funds. This is one of the reasons that closed-end funds tend to outperform open-ended funds over the longer-term.

Put another way, if we launch investment companies and then wind them up in reaction to cyclical market movements, and inevitably do that with a time lag, aren’t we just guaranteeing that we pile in at the top and sell out at the bottom?

James Carthew is head of research at QuotedData.

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