Investment company bargains abound following the bout of discount widening that has plagued the sector. We have seen some welcome proactive moves by boards to address the problem.

What does not seem to have emerged yet is much aggressive action by discount players. This might be because in recent years it has been slim pickings for the arbitrageurs that used to target the sector. Might they make a comeback?

These arbitrageurs looked to profit from discount closing. They would buy an influential stake In an investment company but would part fund that by short-selling the underlying portfolio or some facsimile of that.

That reduced the amount of capital needed to mount a campaign against even quite large investment companies – which meant that just about anything was a target – and it magnified the potential return, so that quite decent returns could be achieved with even a relatively small narrowing of a discount.

Clearly, there is little merit in an arbitrageur targeting a closed-end fund that it cannot influence because voting control is in the hands of investors supportive of the status quo.

A good example of this might be Pershing Square Holdings (PSH ), which I wrote about six months ago and hold. Fund manager Bill Ackman has about a 23% stake in the company, and I reckon that most shareholders are there because they are fans of his approach. However, the bulk of the underlying portfolio is very liquid and, if promises to address the very wide (about 36%) discount are not fulfilled, an opportunity might arise for someone to try to force the issue.

There are numerous private equity and growth capital funds on significant discounts, but it just is not possible to short the underlying unquoted investments. At best, an arbitrageur could short various indices or baskets of stocks that look to have a reasonable correlation with the unlisted portfolio. That might rule out these funds and trusts with significant private equity exposure such as Scottish Mortgage (SMT ). Similarly, the need for liquidity might tend to rule out arbitraging a trust investing in thinly-traded smaller companies.

However, an arbitrageur might be prepared to take on one of these funds if the discount opportunity was so large that it compensated for the additional risk associated with an imperfect hedge.

The easiest funds to take on are those invested in actively traded listed equities. Two obvious targets are Abrdn New India (ANII ), £303m trust on a 19.7% discount, and JPMorgan Indian (JII ), valued at £618m but trailing on a 17.4% discount. Both focus on large-cap Indian equities and have produced lacklustre returns relative to their benchmarks.

If I was on the board of either, I would recommend share buybacks be stepped up to narrow the discount into single figures, thereby staving off any more aggressive action.

Barings Emerging EMEA Opportunities (BEMO ) is the next 100% listed equity portfolio on the list. It trades on a 17.1% discount, but it is relatively small – with a market capitalisation of £60.5m – which may reduce the attraction. That and the difficulty of shorting some of the stocks in its portfolio.

BEMO’s discount does look anomalous when compared to the enormous premium that JPMorgan Emerging Europe, Middle East and Africa (JEMA ) trades on. JEMA’s shareholders think it merits its premium because it has a portfolio of Russian stocks valued at zero that create some option value, but so does BEMO.

Asia Dragon (DGN ), which I discussed a couple of weeks ago, and trades on a 16% discount despite a bias to large Asian stocks, is another potential target. So too are the £58m market cap Invesco Select Global Equity Income (IVPG ) on 16.3% discount) and £104m Invesco Select UK Equity Portfolio (IVPU ), standing on a 15.4% discount. I could go on.

Henderson Opportunities (HOT ) which is on about a 15% discount is interesting because a genuine old-school arbitrageur has shown up on the register. Saba Capital Management normally seems to fish in the US closed-end fund market but at the end of October 2022, it had a 7.1% stake in the company and was the largest shareholder.

Saba was not a name that I was familiar with, though this website’s Trust Watch did report it buying into JPMorgan UK Smaller Companies a few years ago. I looked to see what else it might hold. Bloomberg does not give much away (often holdings will be registered in nominee names), and 13F filings in the US do not disclose non-US positions, but I saw the firm does manage a US closed-end fund – Saba Capital Income & Opportunities Fund – which does publish its holdings in full.

The first UK-listed name on Saba’s list is PSH. However, in addition to HOT, there are plenty more – Schroder UK Mid Cap (SCF ), Schroder British Opportunities (SBO ), European Opportunities Trust (EOT ), the soon-to-disappear Abrdn Smaller Companies Income (ASCI ), JPMorgan European Discovery (JEDT ). These are fairly small holdings but the $370m (end April 2023) fund is, from what I can gather, just a fraction of Saba Capital Management’s total assets under management which seem to be close to $10bn.

I am not necessarily saying Saba’ Capital Management’s intentions are aggressive, but the conditions are ripe for the return of arbitrageurs to the sector and boards need to be aware of this. Investment companies at risk of attack need to be taking pre-emptive action now.

James Carthew is head of research at QuotedData.

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