James Carthew: Saba's wrong, discounts aren't all bad

We are nearing the end game of Saba’s initial assault on the UK investment companies industry. Based on the outcome of the last six votes, I am fairly confident that Edinburgh Worldwide (EWI ) will prevail, but that does not necessarily mean that Saba will give up and go away.

In a last desperate attempt to win support, Saba actually snail-mailed a letter to EWI shareholders. In it, it lifted four quotes from a variety of articles in support of its efforts. The first of these from The Economist said: ‘It is a damning verdict on the trusts’ managers that their portfolios would be worth more if they were carved up and sold for parts.’

The implication here is that all trusts trading on discounts (well over 90% of them) deserve the Saba treatment. That message suits Saba’s agenda, but it feels like an ignorant statement from a financial journalist.

Discounts and premiums are a natural by-product of closed-end structures and a response to an imbalance in supply and demand for shares.

Share prices and, therefore, discounts reflect the underlying liquidity of the portfolio and the likely hit to net asset value (NAV) were a portfolio to be liquidated in a hurry. Discounts also reflect an estimation of the costs that would be incurred in such a situation, such as the break costs for the manager’s contract.

Share prices also reflect investors’ perception of the ability of the manager to add or subtract value through their decisions. There is a close correlation between wide discounts and trusts that have experienced a short-term bout of disappointing performance.

Discounts are not intrinsically bad, but volatile discounts introduce a risk that your purchases and sales could be mistimed. Overly wide discounts invite attention from the likes of Saba and also from investors with deeper pockets and longer-term time horizons.

The bid for BBGI Global Infrastructure (BBGI ) at a premium to NAV and a 21% premium to the prevailing share price is a case in point. It illustrates the upside available in that sector and the renewables sector. It also reinforces my view that the cost disclosure issue is causing professional investors to act irrationally.

Apart from castigating boards for their failure to control discounts, the other focus of Saba’s argument was that boards had presided over unacceptably poor performance. The second quote in Saba’s leaflet came from an article in this publication which named three trusts that the author felt had woeful performance records and ‘quite frankly deserve to be wound up’.

As I have pointed out, Saba cherry-picked its statistics to support its claims. It also targeted trusts in cyclically out of favour areas such as small-cap, growth, and commodities.

Nevertheless, the boards of Keystone Positive Change (KPC ) and Henderson Opportunities (HOT ) had already come to the conclusion that their trusts did not have a long term future and were working to find solutions that that they felt would provide an equitable outcome both for those investors who wanted to take their cash and invest it elsewhere and those that wanted to continue to back their respective investment approaches.

For the remaining five trusts, the central question was: would shareholders see past the short-term upside from discount narrowing to the potentially much more lucrative opportunity when investment cycles turn in these trusts’ favour.

Here, helpfully, we come to the third quote – taken from the Financial Times – which begins: ‘Weinstein is offering a faster solution than waiting for the sector to come good.’

In this respect, the defence was helped by Saba aggressively buying stock, driving discounts down to unnatural levels and removing any prospect of further upside from discount narrowing. That simplified the choice down to: do I want to switch into a trading strategy focused on discount narrowing and with less robust corporate governance, or stick with my existing exposure?

I have been really pleased to see that investors have overwhelmingly embraced the second option. Momentum investing has been so well rewarded in recent years, with the success of the Magnificent Seven, for example, that suggesting that something that has had a run of difficulty might still be worth a closer look often seems to fall on deaf ears. However, as I have tried to highlight over the past few weeks, many of these trusts have track records of delivering spectacular NAV upside once markets turn in their favour. If down the line you have doubled or trebled your money, by all means think again, but do not cash in at the bottom of the cycle.

Saba’s last quote, which was in a Telegraph article said: ‘Saba has done the whole sector a big favour. The investment trusts need to remain dynamic, focused and innovative if they are to survive, and that is only going to happen if there is some form of punishment for failure.’

Here, I have mixed views. That middle bit about the need to be dynamic, focused, and innovative, I could have written myself. Where I disagree, is with the idea that trusts needed to be scared into action. The sheer scale of corporate activity over the past couple of years reflects boards stepping up and acting on their own initiative and in response to feedback from existing shareholders.

Saba has not done the sector any favours. It has forced these seven trusts to run up enormous bills to fight off its unwanted aggression, whilst also disrupting and delaying returns of capital from two of the targeted trusts. Worst of all, it has created sizable overhangs of stock on share registers that could take months to resolve. It must acknowledge that it failed, and work with the boards it targeted to achieve exits from its positions that are fair to all shareholders. Thrashing around aimlessly, perhaps even launching attacks on other trusts, will get it nowhere.

James Carthew is head of investment company research at QuotedData

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