Should you be concerned if activists target your investment trust?

A number of issues, including poor share buyback plans, extensive discounts, and underperformance, have made some trusts open to criticism from activist Saba

We look at the warning signs and how to determine when a takeover might not be such a bad thing. Could your trust be the next target?

Investment trusts are common among do-it-yourself investors, but activist investor Saba Capital Management may have set some people on edge as it gets off to a great start this year.

It has already started a second attempt to remove the Edinburgh Worldwide board, but the plans were turned down. Additionally, it disclosed a 53.3 percent stake in GCP Infrastructure and apparently succeeded in changing Smithson to an open-ended fund.

Saba, a hedge fund group with headquarters in New York, began its historic campaign in December 2024 and is only getting stronger. It has suggested shake-up tactics, narrow discounts, and board replacement.

While some experts have questioned Sabas' motivations, others believe that some sort of intervention was long overdue because boards had grown complacent due to excessively large discounts, poor performance, and uncompetitive fees.

Is it possible for Saba to pursue additional closed-ended funds?

Why do activists care about trusts?

In 46 of the 305 UK-listed investment trusts, Saba, which is led by former Deutsche Bank trader Boaz Weinstein, owns at least 10% of the shares. Herald Investment Trust (30.7 percent as of mid-January) and Edinburgh Worldwide (30.1 percent) are its largest investments.

Yet it is not the only local activist. Wealth manager AJ Bell claims that Allspring owns shares in 46 investment trusts and 1607 Capital Partners in 40. There are many more that operate on a smaller scale.

A wide discount is often likely to pique an activists interest. Investment trusts are traded at two prices: the share price, which is what investors really pay to purchase and sell shares, and the net asset value (NAV), which is calculated by dividing the value of the trust's underlying assets by the number of shares.

When the trust is trading at a premium, the share price is greater than the NAV. It is trading at a discount when it is less than the NAV. Investors can effectively buy assets worth 100p for 90p at a 10% discount to NAV. An activist's primary objective is to make money if the discount expires.

Huge savings and weak trusts.

Trust discounts could be a cause for concern. Keep an eye out for trusts that are trading at a larger discount than their sector average and have consistently underperformed their peers. The Lindsell Trains discount, for instance, is 21.3 percent, while the global sector average is 8 percent. According to Trustnet data, the trust has returned -27.7 percent over the past three years, compared to the sector average of 37.9 percent.

Think about sectors as well. In the UK Equity Income sector, only three out of 19 trusts have outperformed the market in the past ten years. Because of this, the group might become a target since investors might be more inclined to switch from underperforming active investments to market-tracking passive ones.

Scottish American is an underperformer trading at a 9.2 percent discount, which is much wider than the 3.1 percent average for its Global Equity Income sector, according to Dan Coatsworth, head of markets at AJ Bell, who suggests that the company may be vulnerable. Coatsworth states: "Baillie Gifford, which oversees a number of other trusts already vulnerable to Saba's campaigns, manages the trust. Given the most recent Edinburgh Worldwide loss, the activist may feel pressured to put pressure on Baillie Gifford.

Although the industry is unpopular among investment trust users, some infrastructure trusts are being targeted because their assets are in high demand.

"In this case, a better return can be made by selling the assets or buying back large amounts of stock rather than investing in the portfolio," says Thomas McMahon, head of investment companies research at Kepler Partners. While the manager might be distracted, outside activists occasionally have a clearer view of this. A "

Be alert for notifications. Every time a trust's stake in a company increases or decreases by 100 basis points, it is required to notify the stock exchange if the stake exceeds three percent. This should imply that an activist's arrival is not unexpected.

According to McMahon, it can be more challenging to determine whether the shares are held through derivatives or other vehicles, but investment boards and market analysts can assist in understanding these holdings.

An activist's appearance can stir things up, but it's not always a sign to sell. Depending on their intentions, activist investors have the potential to be positive forces.

"Someone pushing for change can be a good thing when you have a strategy that isn't working and investors are selling but the board isn't taking action," stated James Carthew, co-founder of Quoted Data.

As an illustration, he cites Alliance Trust. Significant adjustments were made to the trust's operations after activist Elliott registered, and it ultimately merged with Witan. Carthew claims that "that was a catalyst for positive change."

The presence of an activist can spur a board to action even if their proposals are rejected. The way the industry has behaved since Saba came into existence is indicative of this. The Association of Investment Companies (AIC), a trade group, reports that the average discount has decreased from 15% at the end of 2024 to 12% today.

"Boards have been taking steps to protect themselves," says Annabel Brodie-Smith, the AIC's director of communications. There were a record 27 mergers, acquisitions, and liquidations last year. Additionally, it was a record year for fee adjustments and share buybacks. The "

However, instead of advocating for significant changes in the long-term interests of shareholders, Saba has been accused of attempting to make a quick profit. According to Carthew: "Activists typically don't purchase huge stakes and attempt to compel events to occur. They bring in additional shareholders, make suggestions, and purchase smaller stakes.

Examine an activist's past actions to ascertain whether they are acting in the best interests of shareholders. To get a sense of both sides, read their suggestions and the investment trust board's response.

Compare their reasons with your own, and don't let a possible quick win divert you. "Take a look at CQS Natural Resources," Carthew says. In May of last year, the trust offered investors the chance to sell at NAV through a tender offer. Many investors left even though its discount had already decreased from 15% to 5%. However, since then, the share price has doubled, resulting in a much larger gain for those who stayed.

Why investors should vote.

Think about why you have the trust.

Don't stray from your original motivations for investing, and make sure to vote on any proposals. "Remember that investment trusts are not for a quick buck; they offer a long-term approach to investing, and many offer consistent and rising income over time," the statement from Brodie-Smith reads.

Given the amount of drama surrounding the sector, some investors might be inclined to completely avoid trusts. That would be a mistake, in Carthew's opinion. Although they generate a lot of noise, activists are a normal and healthy part of the market and only make up a small portion of the total.

Investing in possible activist targets may even be a smart move if their objective is to unlock value, according to McMahon. Coatsworth continues, "Boards have realized that when something isn't working, they can't just keep hoping for the best; they need to look at other options.