Arbitraging investment trusts

The credit crisis has done little to dampen arbitrage activity on investment trusts as discounts continue to widen on closed-ended funds.

The most recent high profile example is on the Eaglet Investment Trust, which has seen arbs (arbitrageurs) QVT and Laxey Partners join forces with Knox D’Arcy in seeking a tender offer on the struggling small-cap fund.

As well as replacing Unicorn as trust manager and appointing three new directors, the trio want to secure a tender offer of between 50% to 100% and raise a further £100m in capital. Other arbs have appeared on the shareholder register of Perpetual Japanese, Fidelity Asian Values and Witan Investment Trust in recent months.

According to Charles Cade, head of research at Winterflood, the level of corporate activity within the closed-ended fund sector will continue to pick-up.

“While credit conditions have tightened, the widening discounts across the trust universe mean arbs are here to stay.”

Cade says he sees arbitrage interest as both a positive and negative for the industry.

“In this environment, boards have had to become increasingly proactive in buying back shares, and the level of capital returned is at record levels. Almost £2bn of stock was repurchased in the first nine months of 2007, up 77% year on year."

“This can be good for shareholders who own a trust that is languishing on a wide discount,” he says, adding that however, arbitrage investors often make life difficult for many management groups.

He warns that well-managed funds can become targets of corporate action simply because their asset class is temporarily out of favour.

“This makes it harder for the manager to take a long-term view, and can force funds to wind-up at the worst time in the market cycle.”

One of the most active arbitrageurs in the market today is Bruno Sangle-Ferriere’s Carrousel Capital.

Among current holdings is a 19% stake in Fidelity Asian Values. The group also forced a tender offer on Roger Guy's Gartmore European investment trust earlier this year after building up a 40% stake in the trust.

Unsurprisingly, Carrousel chief executive Sangle-Ferriere sees arbs as a force for good.

“I am helping to close the discounts of the funds I am in. It results in clear actions from boards to try and tighten the discount,” he says.

“I do not see how it [arb action] could be a disadvantage – boards always have a way to get over problems. Some shareholders want to continue, and there are a lot of ways for vehicles to do so."

“For example, the vehicle could continue as an investment trust with a discount mechanism, the shareholders could exit into a unit trust run by the provider, or the investment trust could rollover into other existing vehicles.”

1 December 2007