01:08 Mon 01 Feb 2010
Trust arbitrageurs are back but where will they pounce?
The last two years may have seen many investment trusts swinging to massive discounts and back again, but oddly the arbitrageurs, or value investors to their friends, have not pounced.
This is in large part of course due to the fact that they have themselves had very little capital to play with and have had to deal with redemptions from their hedge funds that have prevented them from taking advantage of contrarian opportunities.
Yet they will be back and indeed there are many who argue they will be back soon. the arbitrageurs of course are not the most open investors, tending to keep their cards close to their chests. While the tougher disclosure regime now in place on CFDs will make it more difficult to build stakes secretly, they still do not want to be too public until the moment is right.
That said, one leading arbitrageur, Colin Kingsnorth from Laxey Partners, has told Citywire that he believes the time is coming for the arbitrageurs to return.
He said: 'We have been building our closed-end fund positions for the last six months and see the market as very interesting. There is certainly less capital in the market from hedge funds. There has however been plenty of activity over the last year but the vast majority of it has been hedge funds or traditional investors forcing funds to liquidate and give their cash back or go into run off.
'That has substantially happened and while there are many still in run off that activity driven by the credit crisis has already surfaced if it was going to.'
The next step then for Kingsnorth is for the arbitrageurs to focus less on the real basket case funds and move on to more conventional well-managed trusts with high quality assets but without substantial demand.
There is for Kingsnorth one looming beast of the sector which looks like the most obvious candidate for this: Alliance Trust. 'The larger funds like Alliance which have drifted to circa 20% discounts in the last few months probably should be thinking about their discount policies. Some have and some haven't,' he said.
Successfully forcing corporate action at Alliance Trust would be a career-defining moment for many investment trust arbitrageurs, but it is notoriously hard to do. Kingsnorth's friend Bruno Sangle-Ferriere from Carrousel Capital has tried and failed. The trust's body of largely Scottish private investors have proved unresponsive to their arguments about unlocking capital.
Nonetheless, the trust is sitting at a 16.5% discount and the tax environment has changed since Sangle-Ferriere's last attempt. Some investors with CGT gains locked in the trust may conclude that there is unlikely to be a better time than this to exit and take the 18% charge.
There are many other targets and arguably ones with less baggage attached. Ironically, one of those trusts which might be an easier bet is Kingsnorth's own fund Value Catalyst. It has had a dire run of performance and faces its own continuation vote next year.
This creates two opportunities. Firstly to buy Value Catalyst to benefit from the opportunity there, but also to buy into its top holdings in the certain knowledge that Kingsnorth and his colleagues will need to work hard to extract value to either improve performance to save the trust or meet redemptions if the trust closes.
Richard Scott, a leading investment trust investor with Hawksmoor, said: 'One of the key opportunities for the arbitrageurs are trusts with continuation votes. There is a lot of pressure from the board to ask whether the trust is working. Ironically Value Catalyst is facing its own continuation vote which is rather unfortunate given its recent performance. To realise many of those investments the mangers will have to work very hard to wind things up.'
Yet there will be many who find taking a one-way bet on the success of an arbitrageur a bit spicy and prefer to buy quality trusts with strong management but with the added protection that if they don't perform the arbitrageurs will pounce.
For Scott a number of these opportunities are to be found in the closed-ended fund of hedge fund sector. He has been buying MW Tops. Run by the highly successful Marshall Wace franchise, the trust is trading on a 6% discount, although that has come in somewhat in recent weeks after the group announced it is fund raising for an exchange traded fund version of the trust.
'We have been buying MW Tops. It is a good two way bet. The performance has to improve and it has been at a discount and we like the management.'
Scott's other bet in this area is FRM Credit Alpha. 'Things have really got to get better or the pressure is going to build and build. Fund of hedge funds are going to be in the eye of the storm.'
One things is for certain value investors may go away, but they always come back.
Investment company news bought to you by Citywire Financial Publishers Limited. 