One way to think about Boaz Weinstein’s attack on UK investment trusts is as if it were the Old Firm derby. The outcome is hugely important for those involved and irrelevant to nearly everyone else. A third group of observers have seen enough over the years to hope both sides lose.
Weinstein’s New York-based hedge fund Saba Capital last month launched a campaign to take over seven UK trusts in which it holds minority stakes. He argued in a webcast today that deep discounts to net asset value are evidence that the trusts (run by Baillie Gifford, Janus Henderson, Manulife and Herald Investment Management) have “failed shareholders”. The trusts have responded by putting a gloss on performance while making spooky noises about fees and fire-sale asset values.
Change-of-control votes are scheduled for next month and, with Saba certain to vote for itself, there’s a lot of PR campaigning to get retail shareholders excited. Turnout at trusts’ shareholder meetings tends to be low — Peel Hunt guesses that a median of 35 per cent of shares vote, on a range of 10 to 50 per cent — so an accidental coup is not implausible.
Even unattached brokers are joining in with the campaigning. Here’s Investec analysts Alan Brierley and Ben Newell:
We are deeply concerned about Saba’s proposals on many levels. While the devil is supposed to be in the detail, the latter is conspicuous by its absence. Just how are shareholders expected to make an informed decision with Saba failing to provide even basic information on key fundamental issues including their own track record, future portfolio exposure, fee arrangements, liquidity options and discount control mechanisms. The paucity of information suggests strongly to us that Saba is relying on investor inertia, rather than the strength of its own arguments, for the resolutions to succeed.
Do shareholders really believe that they will enjoy the same level of protection if Saba is successful and the current Board is replaced with a two-person Board, consisting of a Saba employee and a Saba nominated appointee? Moreover, should Saba’s resolutions pass, for those managing money on behalf of clients who either vote for Saba, or don’t vote given this information vacuum, how do they justify such a “leap-of-faith” action to their clients?
Buying into funds at a discount and pushing for control is a strategy Saba has already used in the US. Via Peel Hunt, here’s a list of its 24 disclosed positions in UK investment trusts, including the seven it has targeted so far . . .
. . . and, via Stifel, a chart showing how persistent the sector’s discounts to NAV have been in recent years:
There’s no single reason why trusts’ NAV discounts have widened over the past three years. The big one is rising gilt yields, as higher inflation and interest rates hammered long-duration assets like property and infrastructure. Most funds were too slow to react. Among the private equity, small-cap and growth equity trusts, there are also plenty of examples of inept or lazy management.
The managers, meanwhile, like to blame a regulator that had been relying too much on European legislation.
One of the biggest gripes is that under FCA disclosure rules, fees were double counted. Under EU law ported over to the UK after Brexit, wealth managers are required to disclose fund costs as part of their own. Recurring costs for closed-ended funds are included in the share price, so these products were made to look more expensive. Wealth managers responded by favouring open-ended funds, whose charges can be more discreet.
This wouldn’t be a problem if the Association of Investment Companies had kicked up more of a fuss before the disclosure rules came into force. While a late lobbying effort convinced the Treasury and FCA to suspend double-counting requirements ahead of a law change expected this year, for now we have limbo, with investment platforms threatening to delist trusts that quote their fees at 0 per cent.
Regulatory burden is another bugbear, including around research. It’s well known that Mifid II unbundling has reduced both the quantity and quality of research on smaller companies, including investment trusts. Less well known is that, post-Woodford, the FCA has ramped up pressure on wealth managers to demonstrate that investment decisions are being researched.
Consolidation among wealth managers makes for bigger firms, and those firms are applying a higher cut-off value on the trusts they are willing to research in-house. Smaller trusts get sidelined. Individual private-client managers who want to take a punt on a fund that has not been researched centrally are required either to do the work themselves or employ a third-party analyst. It’s safer and easier not to bother.
None of this excuses a trust’s poor performance, but it does little to support the case for change either. Saba will have the same regulatory burdens, and might not be fully up to speed about what’s expected in the UK. For example, its coup attempts look incompatible with AIC best practice advice that the majority of the board should be independent of the manager, and will test the Companies Act 2006 requirement for directors to act fairly in all shareholders’ long-term interest.
Saba’s proposals “suggest a distinct lack of understanding, bordering on contempt,” says Investec:
The potential conflicts of interest are material and crystal clear. We note that the AIC Code states that representing a significant shareholder is likely to impair a Director’s independence. Do shareholders really believe that the proposed arrangements will provide them with the same degree of investor protection moving forwards?
The structure of the proposed Boards will bear absolutely no resemblance to anything in the UK closed-end market and Saba appears intent on introducing its own corporate governance model. In the UK, a fully independent Board has been widely regarded as best practice for more than a decade, and non-independent Directors have long been frowned upon by most investors. However, Saba is initially proposing a two-person Board where both Directors are effectively non-independent.
It is difficult to see how the reconstituted Boards of these companies could observe the Listing Rule requirement that they are able to act independently of the investment manager, meaning that their Main Market listing would be jeopardised.
Of course, investors might question why they should care much about regulation that has failed them. The FCA’s Consumer Duty already requires underperforming and subscale trusts to restructure so, in a well-functioning market, activism wouldn’t even be needed.
Critics accuse Saba of being an opportunist asset stripper with no interest in long-term NAV growth. The team at Panmure Liberum says its US raids “consistently reveal a pattern of short-termism, disruptive tactics, and governance changes that undermine long-term shareholder value”.
It’s an accusation that should be simple to test, but finding performance data for Saba funds is not as easy as it might be. The annual report for its flagship Closed-Ends Fund ETF offers the following claim . . .
The Fund’s performance also outperformed its benchmark index (S&P 500) for the one-, three-, and five-year periods ended June 30, 2023 and since inception.
. . . while presenting the following table, which appears to show underperformance for the one- and five-year periods ended Nov 30, and since inception:
According to Investec’s calculations, Saba’s closed-end ETF has underperformed its benchmark in seven out of eight calendar years. A strong run since October 2023 helps the total scores, without which the annualised total return would be just 6.7 per cent. Its management fee is 1.1 per cent a year in addition to costs and interest charges that raise the total annual expense to 5.81 per cent.
In the US, Saba’s strategy has collided with BlackRock and prompted calls for a law change: the Increasing Investor Opportunities Act amendment, introduced in 2023, seeks to block activist investors from forcing closed-end funds into liquidity events or strategy change.
Saba’s UK actions look carefully timed, as they coincide with both the Christmas break and selling by wealth managers following changes to capital gains tax that came into effect in October. They might also reflect a need to cast the net wider when asset gathering. Accusations of opportunism cannot be dismissed easily.
Nevertheless, it might be argued that Saba has delivered to the industry an overdue kick up the arse. A threat of activism ought to encourage trusts to adopt stricter short-term discount control measures, such as share buybacks, says Peel Hunt:
This can be thought of as not having to be the fastest runner to escape the bear, just not one of the slowest, as there would be less discount compression opportunity and other lower-hanging fruit for the activist investor to pursue. [ . . . ] We see a situation where adopting a robust single-digit discount control policy is the only way some of these trusts can successfully defend against such an approach.
And importantly, it shows that closed-end fund discounts should remain permanently narrow, because once an activist gets involved it’s game over. Among the seven funds targeted by Saba is Baillie Gifford-run Keystone Positive Change, which had already announced plans to wind up and offer a 100 per cent cash exit.
Investec makes the same point:
[These] attacks have nothing to do with the performance record, and therefore almost any investment company trading on a wide discount is potentially vulnerable.
We believe that the rest of the industry needs to review buyback parameters, both in terms of quantum and levels. While this may adversely impact the marketability of these companies in the short-term, the NAV enhancements must be more palatable than ultimately having to deal with a hostile attack, the associated costs, and perhaps then having no alternative other than to provide an exit on a much narrower discount, which would also have to be offered to all shareholders.
So, unlike the Old Firm derby, this is probably going to be worth watching.
Further reading:
— Weinstein wants to be ‘white knight’ of UK stock market (FT)
— Investment trusts hit back against activist Boaz Weinstein (FT)
