Both the relative and absolute performance of European Opportunities Trust (EOT ) have been poor in recent years. There are two main reasons for that – the fraud at Wirecard, which was far too large a position in Alexander Darwall’s portfolio, and the general aversion to growth stocks that was triggered by rising interest rates. The board and manager have apologised for the former and taken steps to avoid any repeat of it. It is extremely regrettable, but it is a sunk cost. 

As to the latter, there are encouraging signs that inflation is coming under control, especially in Europe, and that interest rates have peaked. This could mean that EOT’s fortunes are about to change for the better.

Nevertheless, given that the shares fell to 18% below net asset value (NAV) last summer, wider even than the level it hit in the Covid panic of March 2020, it was perhaps inevitable that this would attract the attention of discount-driven investors.

The highest profile and vocal of these in recent months has been Saba Capital. It announced a 5% stake in the trust on 8 September and now holds just shy of 10%. However, according to Bloomberg (which is not always totally reliable), the sector’s other leading value investors are prominent on the register: 1607 Capital Partners owns over 13%, Allspring Global Investments more than 12% and City of London Investment Management above 6%. Each of these invests to make money out of narrowing discounts and collectively it looks as though they own over 40% of the company. 

EOT has recently published final details of its proposed tender offer. The exit price will be calculated based on the NAV at 29 January and cash will be paid out on 5 February. The exit price will be at a 2% discount, which compares to the current valuation gap of 7.4%. I do not think that this will solve the investment trust’s problems, and I think there is a good chance that the discount will widen again afterwards.

Why do I think the share price will weaken again? Well, the tender is limited to 25% of EOT’s share capital and the investors who were holding the shares for the discount narrowing opportunity and want to exit entirely will not be able to get out in full. In fact, unless the discount stabilises below 5%, I think there is a good chance that the tender will be taken up in full and then there will be calls for the board to do another one well before the conditional tender planned for 2026 if investment returns don’t beat the trust’s benchmark..

Given that EOT has a relatively liquid portfolio, a more effective course of action would have been to step up share buybacks with the idea of driving the discount down to low single digits.

The modus operandi of the discount players does vary. In London, we are just getting to know Saba. However, I get the impression it wants a cash exit as close to asset value as possible and as quickly as possible. Some of the others would be more prepared to play the long game – waiting for a recovery in the trust’s fortunes to trade the shares out in the market, perhaps also hoping to capture some of the benefit as the NAV recovers rather than hedging out all of the underlying market exposure.

There is a recent interview with Saba’s Boaz Weinstein on YouTube that gives some interesting insight into their thinking. He talks about looking for the closed-end funds that are trading at the biggest discount but where there is nothing broken about them. He says that the discounts could be eliminated if ‘the managers snapped their fingers and made the closed-end fund… into an open-ended fund.’

That is an overly simplistic view. We know that boards, not managers, hold sway in London-listed closed-end funds and they only derive that power from shareholders. They would need to approve anything as radical as open-ending a fund and often would be reluctant to give up the benefits of the closed-end structure.

The other problem with that idea is that shifting from closed to open ended might solve the discount problem, but it is simply not a practical solution for the vast majority of closed-end funds.

Looking at some of the other companies targeted by Saba, in recent weeks it has announced an 11% stake in Herald (HRI ), the technology smaller company fund by Katie Potts; a 10% position in BlackRock Smaller Companies (BRSC ), and a 10.9% stake in Edinburgh Worldwide (EWI ).

There is a pattern here that seems to be repeated across Saba’s other targets. These are all growth-focused funds that are temporarily out of favour because of shifting market sentiment related to rate rises. Patient discount players can invest in the knowledge that at some point, maybe soon, the tide will turn back in their favour.

Another consideration is that each of these three trusts is investing in smaller companies. By doing so through a closed-end structure, they can back smaller less-liquid names than they would be able to in an open-ended fund. They do not have to keep cash on hand to fund potential redemptions, and the managers can take a much longer-term view.

Were these companies to open-end, short-term investors might be able make a quick buck and move on, but ongoing investors would be considerably disadvantaged. Beyond the liquidity argument, there are plenty of well-rehearsed reasons as to why closed-end structures are better than open-ended ones. 

Nevertheless, for the boards of these trusts, there is a difficult balance to strike. Boards have responsibilities to all investors, not just the ones who are in it for the long term, nor the ones making the most noise today.

However, what these boards will recognise is that an asset value based on market bid prices (as all NAVs are) is not the same as the value you would achieve if you tried to liquidate a relatively illiquid portfolio in a short timeframe. That will colour what response the boards think is appropriate.

James Carthew is head of research at QuotedData.

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