If the Variable Annuity Life Insurance Company (VALIC) of Houston, Texas has its way, the USLife Income Fund, a $53 million closed-end fund it manages, will head in a new direction. VALIC is a unit of American General Annuity Insurance Company, also of Houston.

The fund's adviser is asking shareholders to approve several proposals including allowing the fund to issue a second class of preferred shares of the fund, or issue senior securities, according to a proxy statement filed with the SEC August 2. The capital raised by the issuance of these securities would be used to invest in below investment grade or "junk" bonds, according to the proxy.

The USLife Income Fund, which invests for high current income, had 54 percent of its assets in investment grade fixed-income securities and 46 percent in junk bonds, according to the fund's most recent semi-annual report filed with the SEC in March.

It is not unusual for a fund to chart a new course or consider new initiatives. But, it is unusual that VALIC is attempting to change the nature and structure of the fund just nine months after shareholders frustrated an attempt by dissident shareholder Stewart J. Horejsi of Salina, Kansas to change the fund from an income fund to a total return fund. Horejsi manages assets predominantly through a handful of family trusts.

VALIC is asking shareholders to amend the fund's articles of incorporation to allow the fund's board to authorize the issuance of preferred stock. Under the plan, the board could then authorize the issuance of preferred stock of up to one-third of the fund's net assets.

Preferred stock provides leverage a closed-end fund can use to enhance the fund's returns. Preferred stockholders are usually guaranteed a fixed rate of return. A fund uses the capital raised from the issuance of preferred shares to invest in securities which it hopes will provide a return higher than the rate promised to preferred stockholders.

If the return earned by the fund's investments is greater than that owed preferred stockholders, common stockholders of the closed-end fund will benefit.

But if the earnings are insufficient to cover the cost of the fixed payout promised to preferred shareholders, the fund's share price could drop or the dividends paid to common stockholders could be cut.

That possibility could translate into too much risk for current investors, said one shareholder. On August 16, Horejsi, who owns 14 percent of the shares of USLife Income Fund, filed a preliminary proxy statement opposing the fund's proposals that would allow the issuance of preferred shares and subsequent investments in junk bonds.

"A whole lot of people could end up owning something they never expected to own," said Horejsi in an interview. But Horejsi is not just concerned about VALIC's attempts to increase its investments in junk bonds.

The Aug. 2 proxy for the USLife Income Fund also says that the preferred shares would not be sold in a public offering, but privately to institutional investors with no ties to the fund's adviser. The preferred shares would also carry voting rights that would require a majority of the preferred stockholders, in addition to the common stockholders, to approve any significant changes to the fund. Such proposed changes could include opening the fund or changing the fund's investment restrictions.

Some closed-end fund investors say they wonder whether VALIC plans to dilute the voting power of Horejsi who has expressed an interest in taking a more active role in the fund's future direction.

"While U.S. Life is a good manager, this looks like a move to dilute his interest and thwart his attempt to get control [of the fund]," said George Karpus, president and CEO of Karpus Investment Management of Pittsford, N.Y. Karpus is an investor in closed-end funds for the benefit of his advisory clients.

"I think they are trying to dilute my holdings," said Horejsi. He said that several months ago talks ended between him and VALIC about the possibility of selling back his shares to the fund.

VALIC did not return calls seeking comment.

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