The average discount across all investment trust sectors stood at 16.92% at the end of October, the widest discount for a month-end since December 2008, when it reached 17.73%, according to Morningstar.
Alternative trusts have been hit the hardest. At 55.52%, Growth Capital was the Association of Investment Companies sector with the steepest discount last month, followed by Property UK Residential (53.71%), Property - Europe (47.99%) and Private Equity excluding 3i (35.7%).
The discount of Renewable Energy Infrastructure, a sector that consistently traded at a premium until September last year, has widened to 25.62% as of month-end, a historic low. Trading at an average 22.8% discount, the Infrastructure sector presents a similar story.
The number of alternative investment vehicles in the UK trust arena has expanded significantly in recent years, a sector which is inherently sensitive to interest rate fluctuations.
Pietro Nicholls, portfolio manager at RM Funds, said the issuance of these products during a period of negative to low positive yields has collided with a material rise in global risk-free rates, leading to a wider reallocation of assets away from riskier alternatives.
"While these market dynamics are rational, the sector still confronts numerous challenges," he added. "Issues such as the need for better cost disclosure and governance shortcomings across various boards warrant attention."
Surge in shareholder activism
The sector's deep discounts have driven a surge in shareholder activism in recent months, advocating for enhancements in corporate processes, transparency, governance and even capital allocation strategies.
Investment trusts such as Digital 9 Infrastructure, Hipgnosis Songs, European Opportunities and Home REIT are some examples of vehicles that have been publicly challenged by shareholders this year.
"This activism serves as a critical mechanism for addressing sectoral issues, although it must be balanced against the interests of all shareholders and stakeholders, whose insights might not always be accessible to the public investors," said Nicholls.
Nick Britton, research director at the AIC, said the growing interest of activists in the investment company sector is a function of the deep discounts at which many companies trade.
Saba Capital eyes $500m for activist UK investment trust fund
"Activists invest where they see value, and they may target out-of-favour companies with strong performance records or attractive underlying assets," he said.
Saba Capital, the US activist hedge fund led by Boaz Weinstein, has been building up stakes in UK investment trusts in the last 18 months, including European Opportunities, Henderson Opportunities, Schroder UK Mid Cap and Baillie Gifford US Growth.
Last month, Investment Week reported that the firm has been fundraising for a targeted $500m from investors for the launch of a fund that aims to take activist positions in UK investment trusts holding listed equity.
The vehicle will take positions in around 20 UK investment trusts, with the aim of narrowing their discount through activism, according to a person familiar with the matter. Investment Week understands Saba Capital is currently growing a $3bn exposure in the sector.
"The current wide discounts that afflict the investment companies sector look like a gift for activist investors such as Saba and, to be honest, we are not too surprised that it has taken a keener interest in the UK market," said James Carthew, head of investment companies at QuotedData.
According to Carthew, Saba's modus operandi is to buy big investment trust stakes on wide discounts and agitate for the company to buy it out at asset value.
In its first public statement about a UK investment trust, the firm said last month they would be voting against European Opportunities' continuation vote on 15 November unless a full liquidity option at NAV was provided to shareholders.
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Saba Capital has also firmly opposed EOT's proposal for an additional 25% tender offer announced on Monday (6 November), urging fellow investors to reject the continuation vote unless the size of the tender is doubled to 50%.
"What seems less likely to us is that Saba will achieve significant results with its current positions," said Carthew. "Yes, discounts on some of these funds are wider than normal, but only modestly so and not at extreme levels.
"We do not envisage investors supporting liquidations or opposing continuation votes on trusts trading only a few percentage points wider than normal."
The AIC's Britton said activists are shareholders, so their views "need to be properly considered". However, he noted these firms can have a short-term agenda that is not always aligned with the interests of longer-term shareholders.
Shrinkage of the universe
With the average investment trust trading at a near 17% discount, industry players are starting to spot some "extreme valuation opportunities" in the sector, said Darius McDermott, managing director at FundCalibre.
Investment trusts' wide discounts have also caught the eye of private equity money in the last year, as seen by the £511m takeover of Industrials REIT by Blackstone in April, or the $468.8m take-private deal of Round Hill Music Royalty in early September.
"We are already witnessing an uptick in M&A activity, not only in North America but also across UK and European markets, within the alternatives universe," said RM Funds' Nicholls.
"This trend underscores the recognition of intrinsic value within these trades and does not signify a 'broken' UK market, but rather one that is acclimating to a broader high-rate economic milieu."
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Dan Boardman-Weston, CEO of BRI Wealth Management, said shareholder activism and M&A will benefit the investment trust sector in the short term, as it should narrow down discounts.
However, he argued that, through a combination of lost continuation votes, takeovers and activism, the sector could "dramatically shrink" over the coming years. While performance could improve, he said it may "leave the sector in a worse state in years to come".
FundCalibre's McDermott added there is a balance to be struck between stimulating the sector through shareholder activism, managed wind-downs and M&A without leading to a significant reduction of the opportunities available in the investment trust universe.
"That would be disappointing," he said. "I would not want to come and see some of these lovely alternative assets and dividend heroes come and be swept away just because they are trading at a discount."