Saba Capital: Does the US hedge fund have a point on UK investment trusts?
US hedge fund Saba Capital triggered fury and an industry-wide defensive effort when it launched an activist campaign against seven UK investment trusts last month.
The Manhattan-based hedge fund, led by Boaz Weinstein, has laid siege to the trusts, accused them of failing to perform, and pushed for shareholder votes to “elect new directors with a concrete plan to deliver shareholder value”.
Control of the seven trusts now hangs in the balance as investors cast their votes on the proposals in a series of upcoming votes.
Saba’s campaign has sent shockwaves across the often staid and placid world of UK investment trusts. The UK investment industry has mounted a fierce resistance against the plans, with trade bodies like the Association of Investment Companies (AIC) and brokers rallying behind the trusts.
“Saba’s attack on the UK investment companies industry is entirely self-serving,” said James Carthew, head of investment companies at Quoteddata.
“It aims to seize control of these funds to impose its own agenda, book a short-term profit on its investment and then – we suspect – extract management fees from a strategy that investors have shown no appetite for.”
Investec analysts have noted that Saba failed to provide “even basic information on key fundamental issues including their own track record,” as well as potential fee arrangements and liquidity options.
The board of the targeted investment trusts have responded with even stronger language. One, run by Scottish investment giant Baillie Gifford, stated that is was “appalled by Saba’s actions and conduct”.
Meanwhile, Saba is flinging mud right back, accusing the trusts and those supporting them of making false and misleading claims.
Voting deadlines for the decision are fast approaching, with the first of them, for Herald Investment Trust, due to vote on 22 January. Five trusts have deadlines between 29 and 31 January, other than Edinburgh Worldwide which is set to vote on Valentines Day.
Turnout at shareholder meetings for trusts is often low. Peel Hunt has estimated an average of only 35 per cent of shares vote on corporate policy. Saba’s stake in the trusts, which ranges between 19 and 29 per cent, will therefore mean it has a chance of pushing its proposals over the line and winning board seats across the companies.
So, should investors in these trusts be worried about what a Saba takeover could do? And is there any merit to Saba’s criticism?
Saba Capital’s case
Saba’s central claim is that the current boards have failed to hold the investment managers at Baillie Gifford, Janus Henderson, Herald Investment Management and Manulife, to account.
All of the trusts targeted have suffered from double digit gaps between their share price and the value of their underlying assets, while five have posted double digit underperformance to their benchmark indices over the last three years.
However, this is common across the entire sector: The average investment trust (excluding giant 3i) sits on a 16 per cent discount to underlying assets currently.
Nevertheless, Saba’s claim that the entire UK trust market has been underperforming, and that trusts clearly need to evaluate steps to better improve performance, is undeniable.
Tiny funds with long records of underperformance have frequently come under criticism from analysts for complacency, as boards may have no incentive to vote for a wind-up even if the trust is failing to deliver.
Before entertaining the aggressive approach of Weinstein, however, Investec analysts say the industry on the whole should be looking to close the valuation gap with share buybacks.
“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,” they said.
Saba chief Boaz Weinstein has floated merging “a number of funds”, adding that they would “benefit from scale”.
“We might not merge all of them, the ones with a lot of Spacex maybe have a different path. Maybe they do not. We are going to do the best thing for us and you,” he said.
Saba has received positive feedback for raising the issue of lack of investment from boards in their own trusts, with the activist investor noting their stake in trusts far outpaces the stakes held by their own boards.
Henderson Opportunities’ board owns only 6,837 shares, while Herald’s board owns less than 0.05 per cent of all shares in the trust.
The investment trust case
To fight back, the seven investment trusts (and their supporters) have been attacking Saba from almost every angle, from their performance to their fees to their plans for the trusts.
A primary objection to the hedge fund takeover is that according to Investec’s calculations, Saba’s flagship ETF has underperformed its benchmark in seven out of the last eight calendar years.
Data from Herald Investment Trust, one of the funds targeted by the hedge fund, showed that the flagship ETF had only delivered 4.8 per cent growth annually over the last 15 years, compared to Herald’s 14.1 per cent.
While these numbers have been disputed by Saba, the lack of a clear plan for how the trusts will be run differently from their other vehicles seems concerning to many investors.
Independent shareholder proxy vote ISS endorsed the vote against Saba, stating that the firm “has not presented a compelling case for change, let alone a case for a majority position on the board and a strategy overhaul”.
Fees are another big issue: Baillie Gifford recently warned that Saba’s plan “may introduce substantially inflated fees,” but Saba labelled this “misleading”, arguing it “maintains a highly competitive 1.1 per cent management fee”.
However, Investec calculated that when accounting for costs and interest charges, the annual expense is closer to 5.81 per cent, leagues above the 0.7 to one per cent charged by the Baillie Gifford trusts.
Analysts have also raised serious concerns about the plans for new board members for the trusts, which includes Weinstein himself.
Trust boards and their management are traditionally independent, and while Saba said that further independent directors would be appointed at a later stage, it has left some worried that the ‘barrier between church and state’ in the trusts is at risk of being broken down.
“Two directors would be an unusually small board for an investment trust given the functions the board performs, and having both directors so closely aligned to one major shareholder inevitably raises questions,” said Richard Stone, chief executive of the AIC.
Ultimately, the vote will all come down to turnout and whether the investment trusts can drum up enough retail support for the vote to go their way.