Hedge funds are swooping on the UK’s £200bn Investment Trust sector, which is being shunned and undercut by cheaper competitors.
Investment Trusts have been a cornerstone in UK equity markets for more than 100 years. They are now facing the worst capital raising year they’ve had in 10 years.
hedge fund, including Paul Singer’s Elliott Management, and Boaz Winestein’s Saba Capital, have targeted or threatened to liquidate some investment trusts due to the discount.
Their problems have caused the UK equity market to fall. The FTSE 100 index is close to its record set in February 2023, but this is in stark contrast to the US and European indices which have seen a series of all-time records in 2018.
James de Bunsen is a portfolio manager with Janus Henderson Investors multi-assets team. “That is totally gone.”
Investors have been drawn to government bonds by higher interest rates. This pushed the discount to 17 percent, the highest since the financial crises.
A number of other vehicles, such as exchange-traded funds (ETFs), that allow easy access to global assets have also hurt this sector.
The FTSE 350 index is made up of 27 percent investment trusts. These include Baillie Gifford’s Scottish Mortgage Investment Trust and Bill Ackman’s Pershing Square Holdings of £7,4bn, as well as the £2.5bn RIT Capital Partners Trust.
These funds date back to Victorian times, when they were designed to give individual investors access to investment opportunities across the British Empire. Investors can exchange a certain number of shares without impacting the cash pool available to managers.
This makes it easier to invest in assets which are hard to sell quickly, like private equity or property. Open-ended funds are different, as they constantly issue or redeem shares and units to meet demand.
One hedge fund executive said, “Back in the day you couldn’t purchase shares of emerging market technology so you bought an Investment Trust.” Today, there are a number of ETFs which track emerging market technology and investors now have more options. What was once an extremely unique product has become less unique.
The activists are calling for trusts to refund capital to investors because of their woes.
Elliott revealed a 5 percent stake last month in Scottish Mortgage Investment Trust, a week after FTSE 100 Trust announced a £1bn share buyback attempt to prop up the trust’s ailing stock price. The US investment company had been a long-time shareholder before the disclosure.
According to a source with knowledge of the matter, Saba has accumulated a stake in UK trusts and derivatives worth $1.3 billion.
According to recent regulatory disclosures, these positions include a £70mn investment in Baillie Gifford’s US Growth Trust; an $88mn investment in JPMorgan’s European Discovery Trust; and a £62mn investment in BlackRock Smaller Companies Trust.
Other lenders are now following the example of Scottish Mortgage. According to the Association of Investment Companies, industry buybacks reached a £3.6bn record last year. Other funds have reduced fees, closed their doors or merged, such as the £1.2bn merger that Fidelity and Abrdn agreed to last year.
In a recent statement, Nabeel Bhanji, partner of Elliott, said: “We support the recently announced PS1bn (the largest buyback program ever announced by an UK closed-end funds) and look forward continuing our engagement.” Scottish Mortgage declined comment.
Other investment trusts are fighting for survival. The industry’s lifeblood, capital raising, has dried up. According to the Association of Investment Companies, there were only two initial public offering last year, totaling PS43mn. Secondary fundraising fell from £5.2bn to £1.1bn by 2022.
As a result, a number of investment trusts investing in green energy have not been able to raise equity. This has fueled fears that the UK is being deprived of much-needed green investment due to the industry’s troubles.
Many trusts must hold a vote when the difference between their share price and net asset value reaches a certain threshold. This threshold has been reached or is close by several environmentally-focused trusts. The largest in the UK, Greencoat UK Wind (£3.2bn), is one of them.
According to a source familiar with Elliott’s investment strategy, the fund does not plan to sell its stakes in SMIT. The person added that there is “more” to be done by the investment trust regarding buybacks. Weinstein, however, is weighing several options, including the buyback of shares or the push for fund liquidations, in extreme situations. Saba Capital refused to comment.
Some fund managers blame regulatory changes as well for the decline in demand. The way that investment trust fees are presented to investors in 2022 was altered in response to the new guidelines on rules introduced in 2018. In response to new guidance on rules originally introduced in 2018, the way investment trusts’ fees were presented to some investors was changed in 2022.
A group of 109 trusts warned the chancellor Jeremy Hunt last month that “the current system cannot be allowed to continue”.
The report also said that these rules drove investors into EU-domiciled fund and exacerbated the poor performance on the UK stock exchange. It concluded that a regulatory overhaul would unlock £7bn of lost investment for the UK each year at no cost to taxpayers.
“This is an unintentional self-inflicted goal”, said Baroness Ros Altermann, who proposed last year a private member’s bill to change regulatory requirements. “Other nations are taking advantage our companies. . . The industry is dying.”
Treasury spokesperson: “We are aware of the industry’s concerns, and we are working with the FCA at speed to repeal and replace EU inherited retail disclosure regulations, including investment trusts.”
Hedge funds that are pro-action say that the trusts should prove their worth to investors before waiting for government intervention.
The hedge fund executive said that “some of these discounts can be fixed.” Sometimes you have to change the manager. Other times, the mandate. And other times, the governance structure.