Preferred Share Redemption Strategies in Closed-End Funds: Evaluating the Impact of Virtus Diversified Income & Convertible Fund's Recent Move

The recent redemption of all 1,200,000 Class A Mandatory Redeemable Preferred Shares (MRP Shares) by the Virtus Diversified Income & Convertible Fund (ACV) on October 2, 2025, marks a pivotal moment in the fund's strategy to balance liquidity, risk-adjusted returns, and investor expectations. This move, executed at $25.00 per share plus accrued dividends, was funded through a master margin loan agreement with a commercial bank, signaling a deliberate effort to manage capital structure without disrupting the fund's core investment mandate, according to a Virtus announcement. For investors and market analysts, the redemption raises critical questions about its implications for liquidity, risk profiles, and broader market dynamics in fixed-income and convertible securities.

Liquidity Management and Capital Structure Adjustments

The redemption of ACV's Class A MRP Shares was framed as a routine execution of the fund's mandatory redemption provisions, yet its execution through a margin loan underscores the complexities of liquidity management in closed-end funds (CEFs). Unlike open-end funds, CEFs operate with fixed capital structures, often leveraging debt or preferred shares to amplify returns. ACV's decision to retire its preferred shares-despite the $30 million outlay-suggests a strategic recalibration to reduce leverage and align with its long-term objective of downside protection.

According to a Fitch report, CEFs with robust liquidity buffers, such as those managed by BlackRock, typically navigate such redemptions without significant strain. However, ACV's reliance on a margin loan introduces short-term refinancing risk, albeit mitigated by the commercial bank's willingness to extend credit. This approach contrasts with peers like the Nuveen Preferred & Income Term Fund (JPI), which employs perpetual preferred shares with no fixed redemption dates, allowing for more flexible capital management, as highlighted in a Forbes article. For ACV, the redemption simplifies its capital structure, potentially reducing future administrative and compliance costs associated with maintaining a dual-class share structure.

Risk-Adjusted Returns and Portfolio Dynamics

The redemption's impact on risk-adjusted returns hinges on ACV's ability to redeploy the $30 million freed from its margin loan into higher-yielding assets. The fund's investment strategy, which allocates at least 50% of assets to convertible securities and income-producing equities, is designed to generate equity-like returns with lower volatility, as described on the ACV fund page. Historical data from March 2025 shows ACV delivering a 12.29% annualized total return on NAV over five years, outperforming traditional fixed-income benchmarks.

However, the redemption may alter this risk-return profile. By retiring preferred shares-typically a cheaper source of capital compared to equity-ACV could face higher cost of capital if it issues new shares or raises debt. This could compress net asset growth, particularly if the fund's convertible securities portfolio underperforms. Conversely, the reduction in leverage may stabilize returns during market downturns, aligning with ACV's stated goal of downside protection noted in the Virtus announcement.

Investor Behavior and Market Reactions

The redemption also signals to investors ACV's commitment to maintaining a consistent distribution plan, a key draw for income-focused portfolios. The fund's monthly $0.18/share distribution, sourced from a mix of capital gains and return of capital, has attracted a loyal base of investors seeking predictable cash flows, according to the ACV fund page. Post-redemption, the fund's reduced leverage may lower the risk of distribution cuts, bolstering investor confidence.

Yet, the redemption's timing-just months before the fund's 2030 termination date-raises questions about liquidity preferences. Closed-end funds often trade at discounts to NAV due to supply-demand imbalances, and ACV's July 2025 discount of 7.2% suggests lingering investor caution. The redemption appears to address this by reducing the fund's reliance on preferred shares, which can trade at wider discounts during periods of market stress. Post-redemption, the fund's discount narrowed to 1.2% by October 3, 2025, indicating improved alignment between market price and NAV, as reflected in the fund materials.

Broader Implications for Fixed-Income and Convertible Markets

ACV's redemption reflects a broader trend in CEFs to optimize capital structures amid shifting interest rate environments. As noted by BlackRock in its 2025 Fall Investment Directions, investors are increasingly favoring active yield curve management and shorter-duration strategies to mitigate inflation risks. ACV's focus on convertibles-a hybrid asset class sensitive to interest rate movements-positions it to benefit from this trend, provided its dynamic allocation strategy remains agile.

However, the redemption also highlights the challenges of managing preferred shares in a low-yield environment. Perpetual preferred shares, which dominate many CEF portfolios, face valuation risks as interest rates rise, prompting funds to retire them proactively. ACV's decision to redeem its MRP Shares at a fixed price of $25.00 per share offers a template for other CEFs seeking to reduce exposure to rate-sensitive instruments while preserving liquidity.

Conclusion

The Virtus Diversified Income & Convertible Fund's redemption of its Class A MRP Shares represents a calculated move to enhance liquidity, stabilize risk-adjusted returns, and align with investor expectations in a volatile market. While the immediate impact on NAV discounts and distribution sustainability appears positive, the long-term success of this strategy will depend on the fund's ability to redeploy capital effectively and navigate the evolving fixed-income landscape. For investors, the redemption underscores the importance of monitoring CEF capital structures and redemption policies as part of a diversified income strategy.