The Saba seven saga is drawing to a close, but what does it tell us about the prospects for the UK investment trust industry, and whether or not investors should put their money into investment trusts?
Often counted among the top stocks and funds to invest in, investment trusts are a key part of the UK’s investing landscape. Saba’s attempts to take control of seven UK investment trusts has captured the industry’s attention of late, and is moving into its second stage.
As the last of the ‘Saba seven’ investment trusts voted at its Valentine’s Day general meeting, Saba Capital’s campaign to oust the boards of the seven UK investment trusts died with a whimper, rather than a bang. Following the example set by the first six investment trusts to vote on Saba’s proposals, Edinburgh Worldwide’s (LON:EWI) shareholders voted them down by a sound margin. Excluding Saba’s own votes, 98.4% of those cast were against the hedge fund.
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“One thing it’s told us is that investors really like their investment trusts,” Nick Britton, research and content director at the Association of Investment Companies (AIC) tells MoneyWeek. “They’re prepared to stand up for them and defend them, and to navigate their platforms and websites to make sure they can vote on their future.”
By the time Edinburgh voted, Saba already seemed to have become bored of its own campaign. As a Southampton FC fan, I can sympathise. There’s no fun in watching heavy defeat after heavy defeat. My solution is just to stop paying attention to football altogether, but a hedge fund can’t really take this approach with its investments. Instead, Saba is changing its strategy.
Its new campaign appears to strike at the very heart of the investment trust model, by seeking to convert four trusts – two of which were among the original seven, two of which weren’t – into open-ended funds.
This poses some obvious questions. Why did Saba try to dismiss the boards of the seven trusts when it did? What does it tell us about investment trust shareholders that its attempts were so soundly defeated? And are investment trusts still a good investment, or has Saba exposed some serious flaws in the closed-end model?
The original Saba seven strategy
For an excellent breakdown of the thinking behind Saba’s original strategy regarding the seven investment trusts it first targeted, read Max King’s explainer on why Saba sees an opportunity in UK investment trusts.
In essence, Saba has exploited the wide investment trust discounts available, both in the US and the UK.
But having acquired significant positions in these funds and trusts, there was little else it could do with them, without turning itself into a fund of funds, besides attempting to take control of the trusts.
Saba’s stated goal in doing so was to address the discounts to net asset value (NAV) at which these trusts traded. It seems to have assumed that the retail shareholders of the trusts, particularly those who owned their shares through investment platforms, wouldn’t exercise their voting rights.
That assumption proved false. Investment trust shareholders turned out in record numbers to vote on the proposals. This was thanks in large part to efforts from the AIC, whose ‘My share, my vote’ campaign seeks to mandate that investment platforms make it free and straightforward for shareholders to exercise proxy votes through their investing apps.
“The major consumer platforms… did a good job in informing people about voting, getting them to vote and making it as easy as possible for them in the main” on the Saba issue particularly, says Britton. “That was great, but they didn't have to do that.”
That’s why the AIC is lobbying Parliament, in particular business secretary Jonathan Reynolds, to change the law to require investment platforms to communicate votes to shareholders, and prevent them charging shareholders to exercise their votes.
The upshot for now, though, is that Saba’s Plan A was rebuffed. That leaves Saba still in need of an exit strategy.
Which investment trusts is Saba targeting now?
The challenge for Saba is that, while the discounts on most of the investment trusts it targeted have narrowed – both as a result of it buying shares in bulk, and of its efforts to return capital to shareholders – it isn’t in a position to bank the gains.
Selling shares back into the market in the quantities that Saba owns them would quickly diminish their value, and reopen the discounts. Saba needs a way to crystalise the recent gains on its own balance sheet. Bear in mind that Saba likely has a much shorter-term outlook than the average shareholder in these trusts.
Taking control of the trusts might have allowed Saba to pursue a strategy that raised the value of the trusts in the short term, or take other routes towards returning capital at NAV, but shareholders have rejected these attempts.
So instead, it appears to be seeking to wind up certain trusts, and convert them into open-ended funds. This is its strategy for the ‘Saba Four’: CQS Natural Resources Growth and Income (LON:CYN), European Smaller Companies Trust (LON:ESCT), Middlefield Canadian Income (LON:MCT) and Schroder UK Mid Cap (LON:SCP).
The strategy’s announcement also referenced Henderson Opportunities Trust (LON:HOT) and Keystone Positive Change (LON:KPC), two of the original Saba seven whose boards have proposed similar moves independently.
CYN and ESCT were part of the original Saba Seven. MCT and SCP weren’t.
“Of the seven trusts targeted in our initial campaign, we have focused on CYN and ESCT because we believe they are best positioned for an open-ended fund conversion and, unlike HOT and KPC, their boards have not shown an intent to take this action on their own,” wrote Saba’s founder and chief investment officer Boaz Weinstein regarding the selection. “While MCT and SCP were not part of our initial campaign, we believe they have traded at wide discounts for too long and that their shareholders would greatly benefit from an open-ended fund structure.”
Saba has subsequently withdrawn the requisition on ESCT for a period of 30 days following “constructive discussions” with the trust’s board.
Unlike investment trusts, open-ended funds cannot trade at a discount to their NAV. Shareholders who rolled their shares over into the open-ended fund would effectively realise an immediate increase in their value, but without triggering a capital gains liability.
Are investment trusts still a good investment?
Saba’s attempts to address the discount to NAV suggest that there is something irrational about investing in funds that can trade at less than the value of their assets. That isn’t necessarily the case, though.
Closed-ended funds offer a significant advantage to certain types of retail investors; they are able to tap into esoteric, illiquid assets, thanks to their structure. They can also use gearing to potentially increase exposure (to gains, but also to losses); and they are able to offer relatively smooth income over time thanks to their ability to set aside up to 15% of returns per year.
While Saba’s latest proposals might deliver a one-off liquidity opportunity for investors who want to sell in the near future, it’s far from clear that the new funds – even if they retain their present management and strategy – will perform as strongly in the long term as they would if they remained investment trusts.
This is because they can’t pull levers like gearing, and are more constricted as to the liquidity of the assets they can invest in. The AIC’s research has found that investment trusts tend to outperform open-ended funds in similar industries over the long term.
For investors, it boils down to the time horizon they’re investing in, and the kind of assets they’re using investment trusts to access. For some asset classes, investment trusts will always be the most efficient vehicle, regardless of other strategic advantages.
“If you go right to the end of the illiquidity spectrum, something like property and private equity, you'd kind of be almost mad to try and hold it in an open-ended structure with daily dealing,” says Britton. “It just doesn't work.”
For that reason, he says, it is critical that shareholders of the Saba Four trusts read and digest all details of the proposals when they are revealed, and vote their shares when the time comes.
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