DMA - DMA: Structure Change Provides Significant Potential Opportunity

2023-10-22 01:19:18 ET

Summary

• Destra Multi-Alternative Fund has switched its structure from a perpetual fund to a term fund, offering the potential for a massive discount to be realized in the future.
• Saba Capital Management has taken a significant position in DMA, potentially influencing the fund's management and creating an opportunity for shareholders to benefit.
• The fund's term structure includes the possibility of an extension and tender offer for going perpetual; however, it also has a trigger to extend the term out for 3 years.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Destra Multi-Alternative Fund ( DMA ) recently made an announcement that they switched their structure. This took the fund from being a perpetual fund to a term fund. This means the massive discount can be realized at some point in the future. This is a great thing for shareholders as DMA was or nearly was the closed-end fund with the largest discount.

With the announcement, some of this enthusiasm was shown in an upward reaction in the share price. That does mean a meaningful amount of the discount has already been realized. However, the discount here is still massive and might be worth the speculative play over the coming years. Shares have since fallen a bit lower with a struggling overall market.

Being a fund at the largest discount will certainly make you a target. Whether this was a direct result of Saba taking a massive position and speaking with the management or a pre-emptive move by management, either way, investors in the fund have an opportunity to benefit massively. Saba had recently built up a position in the fund, eventually owning just over 12% of the fund.

The Basics

• 1-Year Z-score: 1.15
• Discount: -38.03%
• Distribution Yield: 9.76%
• Expense Ratio: 2.08%
• Leverage: 15.97%
• Managed Assets: $108.6 million
• Structure: Term (anticipated liquidation date of March 31, 2027)

DMA's investment objective is "to achieve long-term performance non-correlated to the broad stock and bond markets." To achieve this, the fund will invest "primarily in alternative strategies and asset classes including real estate, direct private equity, alternative credit, and hedge strategies."

The Opportunity

The fund launched publicly in early 2022, and it quickly went to a massive discount. It's a tiny fund that hasn't produced sizeable historical returns (nor sizeable losses) Destra isn't a large and known name in the CEF space, and its unusual alternative portfolio is probably all factors impacting this.

However, the fund has a longer history than that of a non-listed fund, as it was launched in 2012. I know history is not a guarantee of the future, but historically speaking, this fund hasn't really produced too much in terms of performance.

On the other hand, to be fair, they have beaten their benchmark and category since inception . The fund also hasn't lost a lot either, as they did produce some small gains. The fund was even able to manage to hold up significantly better relative to most fixed-income and equity positions through 2022 on a NAV return basis.

In my first coverage of the fund, I ended the article with this:

If you expect a lot of returns from the underlying investments, history here suggests that isn't going to happen. Instead, the largest return appears to likely come from a discount contraction if it happens. That's just simply my opinion. Others probably differ, which is what makes a market.

That's exactly what has and will be happening now going forward. With a sharp increase on day one of the announcement, some of it is already underway as well.

Term Structure

However, like any term fund, there are a couple of important things to note - with this one, there is also wording for a sizeable 3-year extension.

For this fund, the initial termination date is going to be March 31, 2027 . That's roughly 3 and a half years away. That means that even if the fund does nothing and holds its NAV flat - which it has historically done - you could expect around 11% annualized returns from the discount narrowing alone.

Not too bad of a result. However, the Board also has the usual standard wording in there that they can extend out the term. In this case, the Board, at its sole discretion without shareholder approval, may extend the time for an additional year. That would put the fund out to a termination date of March 31, 2028, or around 4 and a half years out. This is determined if we are in a market crash and they believe that shareholders have a chance to recover some losses before liquidating.

The fund will also have the opportunity to present an "eligible tender offer" to investors. In this offer, the fund may allow 100% of outstanding shares to be redeemed at 100% of NAV. Basically, like a normal tender offer, every investor will have a chance to participate fully and at NAV. That would take place within 12 months of the fund's termination or extended termination date. In this way, it basically still provides a 'term date' for shareholders, but it puts the decision into the shareholder's hands.

This tender offer wording is also a common language in terms of term structured funds.

However, where a bit of an oddity comes in is that the fund also has the ability to extend its term by 3 years, which is not common for these term funds. It would put the extension out to 2030 or 2031. The longer the extension, the less return that can potentially be produced from a narrowing discount.

That said, there are a couple of conditions that would have to be met in order to see management gain this significant extension. Here is the wording from their SEC filing :

(ii) the Trust’s term will be extended for an additional three-year period from the Termination Date or an Extended Termination Date (as defined below) if:

(a) the absolute cumulative return of net asset value is 25% higher at the Termination Date or an Extended Termination Date (as defined below) than at the annual reported net asset value 36 months prior to such Termination Date or Extended Termination Date, or

(b) the Trust satisfies one of the following trading performance targets (with each such target calculated on a simple arithmetic average based on the closing price of the Trust on the NYSE for the six-month period prior to the Termination Date or an Extended Termination Date (as defined below)):

(1) the Trust has traded at not more than 250 basis points less than the average discount of the DMA Exchange Listed Trading Group for 75% of the trading days in the Trust’s then current term;

(2) the Trust has traded at or better than the average discount of the DMA Exchange Listed Trading Group for 50% of the trading days in the Trust’s then current term; or

(3) the Trust has traded at net asset value or a premium to net asset value for 25% of the trading days in the Trust’s then current term.

There is a lot going on here, but a couple of the important points to note is that the fund either has to produce some decent returns in the last 3 years of its life. They have to produce a 25% return on a net asset value basis for 36 months prior to its term date.

Then we have the "or," which is important to note because the fund might produce bad results but can also choose a 3-year extension as long as the fund's discount isn't as bad as its trading group. That puts into place a floor of what the fund can be allowed to trade at in terms of its discount in terms of it having to be nearly the same or even better than peers.

Here is a list of their trading group and the current discounts, data as of October 7, 2023.

XAI Octagon Floating Rate & Alternative Income Term Trust ( XFLT ) is the only fund that is trading at a premium, and while these are some sizeable discounts, the funds are trading much closer to their NAV than DMA currently.

Risks

The main risk here is that while the termination date provides the opportunity to realize the fund's discount, it doesn't guarantee returns. There isn't anything to say that this fund doesn't start losing 10% or more of its NAV each year. Then, the fund gets liquidated at NAV, but NAV just erodes away and results in potential losses.

An additional characteristic of this portfolio, more so than other term funds, is the significant size of the "practical expedient" and level 3 securities. These represent nearly 70% of the portfolio at the end of their last annual report.

The practical expedient is provided by non-listed or private REITs, partnerships, BDCs, or hedge funds, with these investments themselves holding private investments that can often be hard to gauge value on.

For Alternative Investment Funds, including private real estate investment trusts, non-traded partnership funds, non-listed business development companies and hedge funds, that are themselves treated as investment companies under GAAP, the Fund follows the guidance in GAAP that allows, as practical expedient, the Fund to value such investments at their reported NAV per share (or if not unitized, at an equivalent percentage of the capital of the investee entity). Such investments typically provide an updated NAV or its equivalent on a quarterly basis. The Fair Valuation Committee meets frequently to discuss the fair valuation methodology and will adjust the value of a security if there is a public update to such valuation.

So, the private investment exposure here can add some uncertainty in terms of the valuation.

That isn't a slight against Destra, the third parties who provide valuations or the methodology; it's just that some private investments you can't value with 100% accuracy, and you only find the value when you go to sell.

Sticking with discussing the fund's portfolio, it is fairly narrowly invested. The fund has around 70 holdings total, but a few of the largest holdings are fairly concentrated. More specifically, the largest holding is pushing near a 15% weight alone.

The largest holdings are also considered restricted securities. The majority of the fund is invested in restricted securities, so that isn't too much of a surprise.

Conclusion

DMA made a move to provide investors with a significant potential opportunity to realize the discount on the fund. That doesn't guarantee returns, but it certainly can help with the potential even if the fund produces nearly no returns, as we've seen since its inception. Though again, to be fair, its index and category really haven't produced much of anything in terms of returns, either. It also didn't see massive losses in terms of its NAV results.

Overall, this is a speculative bet on a very unique closed-end fund focused on alternative assets.

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