Saba Capital’s stated intention for its intervention in the UK investment trust sector is to narrow discounts and force change on trusts that have seen a run of weakness. It has had some success pushing for change in the US closed-ended sector, but the UK sector is a different beast. Will it provide a shake-up and deliver value for shareholders? Or will it simply disrupt an already fragile sector?
The first question is whether Saba can get other shareholders on side to support its proposals. Norman Crighton, who has served on the boards of eight investment trusts, points out: “The success of any arbitrage depends on the response of the other shareholders. The arbitrager can’t do anything in isolation. They need to convince the shareholders that the alternative is better than the status quo.”
In the US, closed-ended funds don’t have independent boards and have more institutional shareholders. At first glance, this gives activists a significant advantage – a smaller number of shareholders with which to negotiate. In contrast, most UK investment trusts have fragmented, disparate shareholder bases and the largest investors, such as wealth managers, are not always engaged.
However, resolutions only need to be passed with 50% of votes cast. If a significant number of shareholders don’t vote, these resolutions may pass relatively easily. Ben Conway, head of fund management at Hawksmoor Investment Management, says that voting is difficult for many retail investors. This creates vulnerabilities for trusts, particularly where a lot of their shareholder base invests through platforms.
This has been seen with the European Opportunities trust. The trust has many retail investors, loyal to Alexander Darwall, but Saba still managed to force a small tender offer that it has used to increase its shareholding. It is clearly not finished yet, even though the discount on the trust has narrowed significantly.
Equally, its presence on the shareholder register alone can be enough to galvanise a board into action. Although Saba Capital has not intervened publicly, Keystone increased its share buyback programme and promised a continuation vote in 2027 after it raised its stake to 10%.
There is more merger and acquisition activity within the trust sector – Abrdn, for example, has merged its China trust with Fidelity China Special Situations. Troy Asset Management’s Income & Growth Trust and STS Global Income & Growth Trust have also announced plans to merge. Abrdn New Dawn and Asia Dragon merged in July. Abrdn Japan Investment Trust is being rolled into Nippon Active Value, which has also joined forces with Atlantis Japan Growth. None of these are directly related to Saba, but its presence creates a febrile atmosphere in which boards feel the need to act.
In general, says Conway, arbitrageurs can be a necessary tool in bringing discipline to capital markets. He characterises them as a little like wasps: “You may not like wasps, but they perform a vital role.”
However, while Saba has had some specific successes, the recent narrowing of discounts across the investment trust sector is more likely to be as a result of some buoyancy in stock markets, the potential for a resolution of cost disclosure problems and clear signs that interest rates have peaked.
While it is difficult to disaggregate the Saba impact, discounts on the Saba-targeted trusts have not narrowed notably more than other trusts. In areas where Saba does not get involved, such as the renewable energy infrastructure trusts, discounts have also moved significantly. For example, JLEN Environmental Assets has seen its discount halve from 30% to 15% since its low in October, Next Energy Solar has moved from 28% to 20% over the same period. For Saba-targeted trusts, Keystone’s discount has narrowed from 18% to 12%, BlackRock Smaller Companies from 15% to 10% and Herald from 17.5% to 12.5%.
Is it possible that Saba will take its wins and head back to the US? Nick Greenwood, manager of the MIGO Opportunities trust, believes this is a possibility: “It is possible that a combination of an improvement in the cost disclosure rules, a pause in interest rates, some improvement in financial market sentiment do the job for it. These are the biggest factors driving the discounts.” The question is whether this will be enough to satisfy Saba. After all, the discount for European Opportunities has narrowed significantly, yet Saba appears disinclined to exit.
Even if it does exit, there is a worry over what it leaves behind. There is the selling pressure associated with its departure in a range of relatively small trusts. Equally, there is a danger that buybacks reduce the size of trusts at a time when the sector is already struggling with liquidity problems.
However, Conway says some shrinkage may be necessary: “Arbitrageurs usually encourage boards to buyback. In doing so, they leave behind a sector that has shrunk. Discounts are wide, so you do need to increase demand or reduce supply. Demand is falling, so to achieve a reduction in the discount, supply needs to reduce. It may be that the investment trust sector needs to shrink before it can grow.”
This is a view shared by Nick Greenwood: “There has been some oversupply in the investment trust sector, so maybe managers will buyback, or there will be an orderly wind-down of problematic trusts and supply and demand get back into sync.”
A residual problem is that if trusts are smaller, it may make it more difficult for large wealth managers to buy them. This is already a problem for the sector, after significant consolidation among wealth managers. The behemoth created by the Rathbone/Investec deal, for example, may have to deal in lot sizes too big to accommodate investment trusts. Greenwood is more optimistic: “It does assume that the only buyers will be wealth managers, and there are plenty of smaller wealth managers. There are also self-directed investors.”
There is also a chance that Saba Capital reprioritises. The Financial Times recently reported that two of Saba Capital’s funds had lose 7.7% and 8.1% for the year to date in 2023, having been wrong-footed by the rally in markets over the past couple of months. The fund is thought to have some leverage, and it may be that Saba decides to pare back his positions in the UK.
A final problem is that Saba’s intervention doesn’t necessarily get to the trusts that need it most. The fund is only targeting those trusts where it can hedge the underlying investments. That rules out private equity, renewable energy, infrastructure and property, where some of the biggest discounts lie. These trusts will have to rely on a change in market environment to narrow the discounts.
Saba may succeed on its own measures – and it may also benefit from a narrowing of discounts from other factors. However, whether it will help the sector as a whole is open to question. It may galvanise boards to take action and shake-up some sleepy trusts, but as it is generally not targeting distressed trusts or those with the widest discounts, it is not hitting at the point of greatest need.