For UK investment trusts, what happens when Saba seven turns into four?

The question of what investment trusts mean to retail investors is raised by Saba's new strategy after it was defeated by the shareholders of seven UK investment trusts

The Saba seven story is coming to an end, but what does it tell us about the future of the UK investment trust market and if investors should invest in investment trusts?

An important component of the UK investing scene, investment trusts are frequently ranked among the best stocks and funds to invest in. The industry has recently taken notice of Sabas's latest attempt to seize control of seven UK investment trusts, which is now in its second phase.

The campaign by Saba Capital to remove the boards of the seven UK investment trusts ended with a whimper rather than a bang as the final Saba seven investment trusts voted at their general meeting on Valentine's Day. Edinburgh Worldwide's (LON:EWI) shareholders voted down Sabas' proposals by a significant margin, setting an example for the other six investment trusts that voted on them. Ninety-eight percent of the votes cast were against the hedge fund, excluding Saba's own.

Nick Britton, the director of research and content at the Association of Investment Companies (AIC), tells BFIA, "One thing it told us is that investors really like their investment trusts." They are ready to defend and advocate for them, as well as to use their websites and platforms to ensure that they have a say in their future.

Saba appeared to have grown disinterested in its own campaign by the time Edinburgh cast its ballot. I can relate because I support Southampton FC. Watching one heavy defeat after another is not enjoyable. My answer would be to simply stop following football completely, but a hedge fund can't really do this with its investments. Rather, Saba is altering its approach.

Its recent campaign, which aims to convert four truststwo of which were part of the original seveninto open-ended funds, seems to go right to the core of the investment trust model.

This raises some clear concerns. What does the fact that Saba's attempts to fire the boards of the seven trusts were so thoroughly defeated tell us about the shareholders of investment trusts, and are investment trusts still a wise investment or has Saba revealed some significant weaknesses in the closed-end model?

The Saba Seven's original plan.

James Mackreidess' explanation of why Saba sees an opportunity in UK investment trusts provides a great summary of the reasoning behind Saba's initial strategy with regard to the seven investment trusts it initially targeted.

Saba has essentially taken advantage of the substantial investment trust discounts that are offered in both the US and the UK.

However, after gaining substantial stakes in these funds and trusts, it had not much more to do with them than try to seize control of the trusts without becoming a fund of funds.

In order to address the discounts to net asset value (NAV) at which these trusts traded, Sabas stated that this was the objective. Retail shareholders of the trusts, especially those who obtained their shares through investment platforms, may not have exercised their right to vote, according to the assumption.

That guess turned out to be incorrect. Record numbers of shareholders of investment trusts voted on the proposals. The AIC, whose My Share, My Vote campaign aims to require that investment platforms make it simple and free for shareholders to cast proxy votes via their investing apps, was largely responsible for this.

Speaking specifically about the Saba issue, Britton says, "The major consumer platforms did a good job in informing people about voting, getting them to vote, and making it as easy as possible for them in the main." Although they didn't have to, that was still fantastic.

Because of this, the AIC is urging Parliament, and specifically Business Secretary Jonathan Reynolds, to amend the law to mandate that investment platforms notify shareholders of their votes and forbid them from charging shareholders to cast them.

However, for the time being, Sabas' Plan A was rejected. As a result, Saba still requires an exit plan.

Which investment trusts is Saba focusing on at the moment?

Saba faces the difficulty of not being able to bank the gains, even though the discounts on the majority of the investment trusts it targeted have decreased as a result of its efforts to return capital to shareholders and its bulk purchase of shares.

Reopening the discounts and rapidly reducing the value of the shares would be the result of selling them back into the market in the quantities that Saba currently owns. The recent gains must be crystallized on Saba's own balance sheet. Remember that compared to the typical shareholder in these trusts, Saba probably has a far shorter-term outlook.

Gaining control of the trusts might have given Saba the opportunity to implement a plan that increased the trusts' short-term value or find alternative ways to return capital at NAV, but shareholders have rejected these initiatives.

It seems to be attempting to wind up some trusts and turn them into open-ended funds instead. Its approach for the Saba Four is as follows: Schroder UK Mid Cap (LON:SCP), Middlefield Canadian Income (LON:MCT), European Smaller Companies Trust (LON:ESCT), and CQS Natural Resources Growth and Income (LON:CYN).

Henderson Opportunities Trust (LON:HOT) and Keystone Positive Change (LON:KPC), two of the original Saba seven whose boards have independently suggested comparable actions, were also mentioned in the strategy announcement.

Both ESCT and CYN were members of the original Saba Seven. Neither were MCT and SCP.

"Of the seven trusts targeted in our initial campaign, we have focused on CYN and ESCT because we believe they are best positioned for an open-ended fund conversion and, unlike HOT and KPC, their boards have not shown an intent to take this action on their own," wrote Boaz Weinstein, the founder and chief investment officer of Sabas, in reference to the choice. Although they weren't included in our original campaign, we think that MCT and SCP have been trading at steep discounts for too long and that an open-ended fund structure would be very advantageous for their shareholders.

The ESCT requisition was later withdrawn by Saba for a 30-day period after "constructive discussions" with the trusts board.

Open-ended funds are not allowed to trade below their net asset value (NAV), in contrast to investment trusts. By rolling their shares over into the open-ended fund, shareholders would essentially see an instant increase in value without incurring a capital gains obligation.

Are trusts for investments still a wise choice?

In his attempts to address the discount to NAV, Sabas implies that investing in funds that have the potential to trade below the value of their assets is illogical. However, that's not always the case.

The structure of closed-ended funds allows them to access esoteric, illiquid assets, which is a major benefit for some types of retail investors. Their ability to set aside up to 15% of returns annually allows them to provide a reasonably steady income over time, and they can use gearing to potentially increase exposure (to gains, but also to losses).

It is uncertain whether the new funds, even if they keep their current management and strategy, will perform as well over the long run as they would if they remained investment trusts, even though Sabas' most recent proposals might provide investors who wish to sell in the near future with a one-time liquidity opportunity.

This is because they are more limited in the liquidity of the assets they can invest in and are unable to pull levers like gearing. According to the AIC's research, investment trusts typically do better over the long run than open-ended funds in comparable industries.

It all comes down to the investors' time horizon and the types of assets they are accessing through investment trusts. Investment trusts, regardless of other strategic advantages, will always be the most effective vehicle for certain asset classes.

"You'd kind of be mad to try and hold it in an open-ended structure with daily dealing if you go right to the end of the illiquidity spectrum, something like property and private equity," Britton comments. "It simply doesn't work.

Because of this, he says, it is crucial that Saba Four trust shareholders read and consider all of the proposals when they are made public and cast their votes for their shares when the time comes.