Economist Writing Every Day

Boaz Weinstein and the London Whale

Boaz Weinstein is a really smart guy. At age 16 the US Chess Federation conferred on him the second highest (“Life Master”) of the eight master ratings. As a junior in high school, he won a stock-picking contest sponsored by Newsday, beating out a field of about 5000 students. He started interning with Merrill Lynch at age 15, during summer breaks. He has the honor of being blacklisted at casinos for his ability to count cards. 

He entered into heavy duty financial trading right out of college, and quickly became a rock star. He joined international investment bank Deutsche Bank in 1998, and led their trading of then-esoteric credit default swaps (securities that payout when borrowers default). Within a few years his group was managing some $30 billion in positions, and typically netting hundreds of millions in profits per year. In 2001, Weinstein was named a managing director of the company, at the tender age of 27.

Weinstein left Deutsche Bank in 2009 and started his own credit-focused hedge fund, Saba Capital Management. One of its many coups was to identify some massive, seemingly irrational trades in 2012 that were skewing the credit default markets. Weinstein pounced early, and made bank by taking the opposite sides of these trades. He let other traders in on the secret, and they also took opposing positions.

(It turned out these huge trades were made by a trader in J. P. Morgan’s London trading office, Bruno Iksil, who was nick-named the London Whale. Morgan’s losses from Iksil’s trades mounted to some $6.2 billion.)

For what it’s worth, Weinstein is by all accounts a really nice guy. This is not necessarily typical for many high-powered Wall Street traders who have been as successful as he.

Weinstein and the Sprawling World of Closed End Funds

If you have a brokerage account, you can buy individual securities, like Microsoft common stock shares, or bonds issued by General Motors. Many investors would prefer not to have to do the work of screening and buying and holding hundreds of stocks or bonds. No problem, there exist many funds, which do all the work for you. For instance, the SPY fund holds shares of all 500 large-cap American companies that are in the S&P 500 index, so you can simply buy shares of the one fund, SPY. 

Without going too deeply into all this, there are three main types of funds held by retail investors. These are traditional open-end mutual funds, the more common exchange-traded funds (ETFs), and closed end funds (CEFs). CEFs come in many flavors, with some holding plain stocks, and others holding high-yield bonds or loans, or less-common assets like spicy CLO securities. A distinctive feature of CEFs is that the market price per share often differs from the net asset value (NAV) per share. A CEF may trade at a premium or a discount to NAV, and that premium or discount can vary widely with time and among otherwise-similar funds. This makes optimal investing in CEFs very complex, but potentially-rewarding: if you can keep rotating among CEF’s, buying ones that are heavily discounted, then selling them when the discount closes, you can in theory do much better than a simple buy and hold investor.

I played around in this area, but did not want to devote the time and attention to doing it well, considering I only wanted to devote 3-4% of my personal portfolio to CEFs. There are over 400 closed end funds out there. So, I looked into funds whose managers would (for a small fee) do that optimized buying and selling of CEFs for me.

It turns out that there are several such funds-of-CEF-funds. These include ETFs with the symbols YYY and PCEF, CEFS, and also the closed end funds FOF and RIV. YYY and PCEF tend to operate passively, using fairly mechanical rules. PCEF aims to simply replicate a broad-based index of the CEF universe, while YYY rebalances periodically to replicate an “intelligent” index which ranks CEFs by yield, discount to net asset value and liquidity. FOF holds and adjusts a basket of undervalued CEFs chosen by active managers, while RIV holds a diverse pot of high-yield securities, including CEFs. The consensus among most advisers I follow is that FOF is a decent buy when it is trading at a significant discount, but it makes no sense to buy it now, when it is at a relatively high premium; you would be better off just buying a basket of CEFs yourself.

I settled on using CEFS (Saba Closed-End Funds ETF)  for my closed end fund exposure. It is very actively co-managed by Saba Capital Management, which is headed by none other than Boaz Weinstein. I trust whatever team he puts together. Among other things, Saba will buy shares in a CEF that trades at a discount, then pressure that fund’s management to take actions to close the discount.

The results speak for themselves. Here is a plot of CEFS (orange line) versus SP500 index (blue), and two passively-managed ETFs that hold CEFs, PCEF (purple) and YYY (green) over the past three years:

The Y axis is total return (price action plus reinvestment of dividends). CEFS smoked the other two funds-of-funds, and even edged out the S&P in this time period.  It currently pays out a juicy 9% annualized distribution. Thank you, Mr. Weinstein, and Merry Christmas to all my fellow investors.

Boilerplate disclaimer: Nothing in this article should be regarded as advice to buy or sell any security.