US hedge fund Saba Capital is making waves in the UK investment trust industry with its plans to overhaul boards and improve performance. But this week it suffered its first defeat as shareholders in turnaround target Herald Investment Trust HRI rejected moves by Saba and its owner Boaz Weinstein.
There are a raft of meetings to come though, with growth-focused asset manager Baillie Gifford also in Saba’s sights. So far you could say the score is Saba Capital 0, UK investment trusts 1. There are six meetings left, however.
But what does Saba want?
Activist investors are nothing new in the UK equity market. Hedge funds have already urged change at the likes of GSK GSK, where Elliott Advisors attempted to force a change of leadership.
So Saba could be seen as a continuation of this trend, just in the investment trust world. And Saba’s move hasn’t come from leftfield exactly: it’s been building holdings in target companies over time to force change.
In a webinar on Jan. 14, Boaz Weinstein laid out the terms of engagement for the upcoming meetings. The circular stated:
“Saba is convening the General Meetings because we believe the current Boards of Directors and investment managers have failed to perform versus their benchmarks, resulting in deep trading discounts to net asset value, which we believe have only recently narrowed as a result of Saba’s investment.
The company’s strategy is “to deliver substantial liquidity and long-term returns for all shareholders”.
In practice this means:
- Investment trust board directors would be replaced by Saba appointed directors
- Investment trust fund managers would also be replaced (investment trust boards and investment managers are separate)
What Are The Affected Trusts?
Saba is targeting change at the following trusts:
- Baillie Gifford US Growth Trust USA
- CQS Natural Resources Growth & Income CYN
- Edinburgh Worldwide Investment Trust EWI
- European Smaller Companies Trust ESCT
- Henderson Opportunities Trust HOT
- Herald Investment Trust HRI
- Keystone Positive Change Investment Trust KPC.
There is a wide difference in the market size of these trusts, from less than £100 million to over £1 billion.
How Have Investment Trusts Responded?
The targeted trusts have urged their shareholders to vote against the proposals, naturally, and voiced their opposition clearly. But they’ve also offered investors the option of “full-cash exits”, the ability to sell out of holdings at close to the net asset value rather than the share price. As many investment trusts are trading at a discount, this would allow shareholders to cash in at 99% of the value of the underlying assets of the business rather than the prevailing (and in some cases depressed) share price. Saba is also offering that option to investors, if it succeeds in replacing the board directors.
Share buybacks are one way for trusts to control or reduce investment trust discounts. Buying shares back reduces the number of issued shares, thereby increasing their scarcity and driving the share price up. As listed companies have discovered, this can have an immediate boost that is often shortlived.
Tender offers, where investors are allowed to sell back parts of their holdings to the trusts at a pre-determined price, are also part of the defence against Saba.
Saba itself says the trusts are only offering these options to shareholders because of the pressure it has put them under.
Scottish Mortgage Manager Speaks Out
At the Scottish Mortgage Forum in January, co-manager Tom Slater urged individual shareholders to make up their own minds and make their voices heard. He also noted that he personally is a shareholder in all three of Baillie Gifford’s targeted trusts and intends to vote against Saba.
“I invested in the Baillie Gifford US Growth Trust IPO; back in 2018 I made three times my money and I’m a very happy shareholder and believe in what they’ve done,” he said.
He noted that while Keystone Positive Change Trust has struggled due to scale, the board’s plans to address this by transitioning into an open-ended fund is a credible proposal.
Meanwhile, Edinburgh Worldwide’s focus is on small-caps, a sector that has been deeply out of favor over the past years. Slater said: “I think it would be a very bad time to lose access to that approach because I’m very optimistic about the returns that I will generate in the coming years.”
What Has Been the UK Investment Industry Reaction?
It would be fair to say that a “war of words” has broken out between Saba and the investment trust boards, played out in the media, ahead of the meetings. Expect more in the coming weeks as more votes are cast.
While some investors have welcomed the plans to improve performance, some industry figures have cheered the initial success of Herald Investment Trust in rebuffing Saba.
A powerful lobby group is emerging to fight Saba: ISS and Glass Lewis, the independent proxy advisors, argue that Saba has not made a compelling case for change.
Darius McDermott, managing director at Chelsea Financial Services, says the battle between the two sides is just beginning, even after the Herald vote this week.
“Saba has ongoing requisitions with six other trusts—and investors need to build on the positive momentum," he says.
“Engagement with voting rights remains crucial as the next votes approach—and all platforms should encourage investor democracy. In hindsight, this may be looked upon as a famous victory for the retail investor ... and the sector.”
Research firm Edison put out a note urging shareholders to act to protect their interests, warning of governance issues under the new plans:
“The new corporate governance structure pursued by Saba does not guarantee the protection of the rights of minority shareholders [i.e. retail investors] and does not fulfil the Financial Conduct Authority’s listing rules with respect to board independence.
“Saba presents a biased narrative to achieve its objectives and its recent proposals lack the necessary details to make an informed decision to vote in favor of them,” Edison adds.
I’m a Trust Investor, What Should I Do?
It’s worth reading the arguments from both sides. Saba Capital’s position is laid out here, while the arguments against the proposals will be on the trust websites.
If you have a financial advisor, they will be able to steer you in your decision making. There are some complexities to navigate here, including the meaning of “liquidity events”, “tender offers”, and trust-specific terms like discounts, gearing and net asset values.
And there are plenty of resources available across the financial media, with stories ahead of the meetings.
AIC Says: Investors Should Ask These Six Questions
The Association of Investment Companies (AIC) says there are six unanswered questions about the Saba proposals that investors should consider before voting at the general meetings:
1. Are you comfortable with a board of just two directors initially, given that investment trusts usually have three or more?
2. Are you satisfied with the independence of the proposed new directors, given that Saba has stated its intention to put itself forward as a potential new manager of your investment trust?
3. Are you clear about Saba’s proposed changes to the strategy of your investment trust? If so, would this strategy meet your needs?
4. If the proposals result in a change of the underlying assets of your investment trust and a change of the portfolio’s risk and reward, are you comfortable with this?
5. If Saba seeks to change the manager of your investment trust, potentially being appointed itself, are you comfortable with how it would exercise its mandate? Current unknowns include the fees a new manager may charge, levels of gearing they might use and so on.
6. If your investment trust’s current board is offering shareholders a cash exit —as is the case in two out of the seven trusts —what additional advantages does the Saba proposal offer? Would the Saba proposal restrict or alter the existing exit opportunity?
What Happens if Saba Wins or Loses?
With only one meeting decided, this is hard to call. If Saba is successful, this could embolden Saba to look at other trusts it deems to be underperforming.
What’s the Background to the Investment Trust Shakeup?
We’ve previously reported on how the sector has struggled to compete with passive funds after two successive years of strong gains for US indexes. Many investment trusts still sitting on discounts to net asset value (NAV) and last year failed to beat the S&P 500 in share price terms. Underperformance has forced many smaller trusts to close or merge in recent years as investors have voted with their feet.
On the other hand, three investment trusts are among the UK’s biggest companies: Scottish Mortgage, with a market value of £13 billion, the near £6 billion F&C Investment Trust FCIT, and recently merged Alliance Witan ALW. The F&C trust has a Morningstar Medalist Rating of Bronze.
Additional reporting from Sunniva Kolostyak.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
