charles cadeOn arbs
In the late 1990s, there were a handful of arbitrageurs operating in the sector who primarily target...
In the late 1990s, there were a handful of arbitrageurs operating in the sector who primarily targeted the large Global investment trusts, leading to the wind-up of funds such as Overseas IT, Kleinwort Overseas and Dunedin Worldwide.
The introduction of share buybacks/tenders after ACT was abolished in April 1999 enabled investment trusts to buy out the arbitrageurs and remove the overhang of stock from institutions.
This made it hard to build a sizeable stake, and liquidity was reduced by the withdrawal of several investment banks from market-making in the sector.
As markets improved, performance of these arbitrageurs was extremely good, and this helped raise more capital.
With discounts narrowing from 2004-06 and more capital looking for fewer ideas, it was unsurprising that the arbitrageurs became more aggressive about extracting value.
Now, however, they will often look to keep building their position, and the endgame has increasingly become some form of reconstruction such as a tender offer or open-ending.
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.
We expect the level of corporate activity within the sector to pick up. Investors have recently requisitioned an EGM to seek Board changes at Eaglet, while a number of other funds look vulnerable due to significant arbitrage stakes.
Arbitrage investors make life difficult for many groups, but this can be good for investors if it keeps discounts tight. On the other hand, well-managed funds will often 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.
Good or bad, arbitrageurs are likely to remain a feature of the investment trust sector for the foreseeable future.
Charles Cade is head of research at Winterflood
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