Baillie Gifford has estimated US activist Saba Capital could have made a 30% gain last year trading shares in Scottish Mortgage Trust (SMT ), its £11bn global equities flagship. 

Until this week it was not known that Saba had included the widely-held FTSE 100 listed fund in its expansive foray into the £268bn UK investment companies’ sector in 2023.

As we reported yesterday, one of the group’s funds, Saba Capital Income and Opportunities, disclosed an $11m (£8.7m) position in Scottish Mortgage at 31 October in its annual report.  

Citywire can now reveal this was part of a much larger $100m stake in Scottish Mortgage the New York-based hedge fund manager built in its funds  around April last year when the trust sank to a three-year low.  

Saba has since sold the position, taking profits after the trust rebounded 21% in the fourth quarter during a stock market relief rally anticipating interest rate cuts this year. 

Stewart Heggie, Scottish Mortgage’s commercial director at Baillie Gifford, who has been tracking hedge fund activity in the trust’s depressed shares, believed Saba had bought in at a 20% discount and sold when the gap to net asset value (NAV) narrowed to 10%. 

This would imply a December exit meaning Saba was a Scottish Mortgage shareholder for just nine months. 

Heggie calculated Saba’s 10% gain from Scottish Mortgage’s rerating could have generated a 30% return assuming it was triple geared into the position. 

That compares to a 12% total shareholder return generated by the trust last year. At yesterday’s close of 787p the shares still remain about half their £15.28 peak in November 2021.

Saba declined to comment.

Swaps trail

Hedge funds’ trades in investment companies tend to be highly geared, Heggie explained, as in addition to buying shares they also use financial derivatives called swaps to maximise their positions for a minimum capital outlay. 

Speaking to Citywire at the sideline of a Scottish Mortgage forum in the City of London, Heggie said Baillie Gifford had had no contact with Saba, which last year swooped on 35 London-listed closed-end funds to exploit widespread share price weakness caused by high inflation and surging interest rates.  

However, he said Baillie Gifford had followed Saba’s activity in Scottish Mortgage and other investment trusts it manages, such as Edinburgh Worldwide (EWI ).  

Heggie said the use of swaps made it difficult to identify underlying investors, particularly as stakes in companies involving derivatives do not have to be reported to the London Stock Exchange until they exceed 5%. By contrast, the reporting threshold for direct equity positions is 3%.  

However, Baillie Gifford had learned to recognise the investment banks Saba used to buy its swaps, Heggie said. He added Saba was not alone in trading Scottish Mortgage as he had seen ‘a lot’ of hedge fund activity in the shares.   

On-off activist

Saba’s investment in Scottish Mortgage may have been brief but it is significant. It demonstrates that despite its campaign against European Opportunities Trust (EOT ), where it unsuccessfully pushed for a 50% tender offer last month, Saba does not always take an activist stance.  

While Saba is more aggressive than other value investors in the sector, such as the UK’s City of London Investment Management and 1607 Capital Partners and Allspring of the US, its prime motivation appears to be to make an efficient turn on undervalued closed-end funds, rather than indulge in time-consuming disputes.

Besides, Scottish Mortgage would likely have been a tough nut for Saba to crack in a public campaign like the one it has waged against Alexander Darwall’s European Opportunities.

Arbitrageurs such as Saba short-sell the investments in a fund in which they hold a stake. They do this to neutralise the effect of market movements and focus their returns exclusively on any narrowing in its share price discount. 

But with 27% of Scottish Mortgage’s assets held in private companies, it is not possible to do this across the entire portfolio.  

Even using swaps, Saba would have had to stump up around $380m (£300m) to establish a 9%-10% stake equivalent to the one it holds in EOT.    

Receding headwind

Despite last year’s highly unusual boardroom row over the private equity positions that led to the departure of three directors, including former chair Fiona McBain, Scottish Mortgage is not viewed as badly run and in need of a governance overhaul by an activist. 

The trust’s slump in the growth sell-off has left shareholders nursing a 38% loss over three years, but longer-term performance remains strong. Over five and 10 years the shares have returned 64% and nearly 300%. As a result there may have been limited support if Saba had decided to weigh in with a push for Scottish Mortgage to return capital in a bid to narrow the discount. 

At the forum the trust’s fund managers Tom Slater and Lawrence Burns struck a confident note. They insisted their high-conviction approach to picking winners from digitisation, AI, energy transition and healthcare’s technology revolution was the best way to ensure long-term returns. 

While the derating of growth companies both on and off the stock market had been painful for Scottish Mortgage shareholders, the managers said companies such as Latin American e-commerce provider Mercado Libre were growing faster than ever.

‘With mounting evidence that interest rates have peaked that should not a be a headwind going forward,’ said Slater.