Description

ZTR is a CEF (Closed End Fund) trading at a 12% discount to NAV.

Now, before you think “Neeeeext!”, and reach for the “3” button, some details are in order. Zweig Fund holds stocks, treasuries, and money market assets. The last breakdown I got was 29% stocks (big cap, blue chips, I-share/spyder type stuff) and 53% bonds. However, the average duration of the fund is only 2.6 yrs and the average maturity is 4.1 yrs, so these figures obviously include the money market assets.

OK, we’ve established that we have reasonable assets at a discount from fair value. So what. There are tons of CEF’s out there trading at discounts to NAV. The difference here is that ZTR has a “lifeboat” provision that mandates a vote to open end the fund if the fund trades at an average discount of 10% or more during any fiscal quarter. The last quarter, which just ended Dec31, qualified, and thus there will be a vote in Q1 of 04.

Hmmm, you say, this sounds ok, but upon further due diligence I see where the fund underwent a similar vote in 2001, which went down in flames by a large margin. What’s different this time, Mr. Closed-end-fund-at-a-discount-promoter? (With acknowledgements to the Budweiser “real men of genius” commercials!). The difference this time is that the fund has radically changed their dividend policy; In 2001, they were able to convince holders that it was a temporary phenomenon and to hang with. This time, they’ll have a much harder time making that argument, and we’ve seen a lot of yield-hogs selling their shares to more activist shareholders.

What is the new divvie policy and why did they institute it and cause such turmoil? Zweig, like many other CEF’s had a fixed return dividend policy. This was designed to appeal to yield-hogs who wanted a monthly check, even if it was partially a tax-free return of capital sometimes. And, it worked. The fund tended to trade at a premium to NAV. The problem came, when during the bear market, the fund suffered a few years of losses. The part of the divvie that was occasionally return of capital now might lose its tax-free status. This is because the IRS says that investors must pay additional taxes on income from a mutual fund when three conditions are met: the fund has current-year gains; it has accumulated losses from prior years; and the fund pays distributions exceeding those required by the IRS. In other words, what they’re supposed to do is offset their current capital gains with prior loss carry-forwards. It’s actually a beautiful thing inasmuch as this year’s capital gains are effectively tax free; unless you’re holding this thing for the divvie, as most existing shareholders were. They instituted a divvie policy of paying out 0.18% of NAV each month, for a whopping 2.16% yield. In December, any capital gains, if available, would be distributed in that dividend.

OK, so we’ve got a voting situation and a lot of new shareholders who are buying with an eye toward an open-ending. What happens if it doesn’t pass? They can’t have another vote in Q2, but can have another in Q3. (Can’t be consecutive.) If it gets to that point, the odds that it doesn’t pass seem very small, as the only folks buying stock will be activists.

I think there’s a very good chance it never even gets to the first vote though, or it will be irrelevant. The reason is, there were about 20 other CEF’s with similar situations in Q3 of 2003, and I know some traders who were shorting them in anticipation of a divvie restructuring similar to ZTR. None of them ever did it. Inasmuch as only a portion of the dividend will be taxable, and given that many shareholders hold their shares in tax free accounts, they don’t care about the taxability; they DO care about perceived yield. I think there is a good chance that the company will cite the overwhelming desire of many shareholders to reinstitute the old divvie policy, and do just that. The fact that they are keeping their jobs is merely secondary of course. I understand that many of the new activist shareholders are pushing just such a decision, with the implied threat of the open end vote as a lever.

Thus, not only would you pick back up the 12% discount, but you’d likely pick up some sort of premium to NAV again. Not to mention that fabulous 2%yield in the interim. The stock symbol actually has only three letters, is traded on the NYSE, and is very liquid. No promises, but I think the odds are very good.

Catalyst

1) Mandatory vote to open-end.
2) Possible reinstatement of high dividend policy.
3) Ability to buy now due to disappointment of Dec dividend.