Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Investment trusts trade on a stock exchange. This brings certain advantages, such as ease of trading, but it also means that the price doesn’t necessarily reflect the value of the underlying assets in the trust. Trusts can trade at a discount or, more rarely, a premium to their net asset value. What do you need to understand about managing discounts on investment trusts?
What is a discount?
As investment trusts trade on an exchange, the price will reflect supply and demand for the shares and won’t necessarily replicate the value of the underlying assets.
If an investment trust holds 100 shares in Company A at 100p, and 200 shares in company B at 200p, the net asset value of the portfolio will be (100 x 100p) + (200 x 200p) = £500. However, it may trade at, for example, £450 – a discount of 10% per share, or at £550 – a premium of 10%, depending on demand for the shares.
Why do trusts trade at a discount?
There are a number of reasons why a trust may trade at a discount. The fundamental reason is that there are more sellers than there are buyers. This may be because sentiment is weak, and investors think the asset value will go down. If an area is very unfashionable – as Japan has been for much of the past decade, or the UK is today – owners of shares wanting to sell will need to be prepared to offer their shares at a discounted price to attract potential buyers.
Discounts may also widen because of trust-specific problems. It might have seen a change of manager, or a manager is thought to have lost their edge. Even the greatest fund managers will have periods of weakness and investors can lose faith.
Some assets may only be valued a few times a year, so may not be reflected immediately in the net asset value. This might happen with private equity or commercial property assets where there isn’t day to day liquidity and therefore a gap can emerge between the market’s view of the likely value of the assets and the value reflected in the trust. This gap will often be reflected in the discount or premium.
Some trust managers will look to manage the discount, either buying back shares to reduce a discount, or issuing shares to reduce a premium. This is individual to each trust, but the policy will be clearly stated in the trust’s documents.
Why do discounts matter?
A wide discount (compared to its sector peers or its historic average) can provide an opportunity to buy assets at less than their current value. If a trust is trading at, for example, a 20% discount to net asset value, investors are getting 100p worth of investments for 80p. This can be particularly useful for income investors, who can pick up a long-term income stream at a discount.
However, there are no guarantees that a discount will close. Some trade at a long-term discount to net asset value. With this in mind, investors always need to look at a trust’s historic average discount. Is the discount unusually wide? Or is it within its normal range?
Equally, a wide discount can be a sign of distress. It may indicate that investors believe the asset price is about to drop. This is common among trusts where the underlying assets are not traded daily, such as property or infrastructure.
Where are discounts today?
Investment trust discounts today are at an average of 15.6% across all sectors.1 This is their widest point for 20 years, except for the 2008 financial crisis when they hit 17.9%. Their long-term average is 7.6%.
The sectors where the gap is widest relative to history are the AIC Global Sector (6.3%), the AIC UK All Companies sector (5%) and the AIC North America sector (16.5%). In contrast, Japan and Global Equity Income are trading above their historic averages.
There may be reasons for these discounts. It is possible that a single out-of-favour trust can skew the results, for example. At the same time, the discount of any trust shouldn’t be considered in isolation and shouldn’t be compared against trusts in other sectors. However, they can provide a starting point for investors to look for out-of-favour areas that may be trading below their long-term average.
Equally, discounts aren’t always something to be afraid of. As the above graph shows, there will be times when discounts widen out, but they can narrow out over time. The underlying performance of the trust and the relative skill of its manager is likely to be more important over time.
1Source: theaic.co.uk / Morningstar as at 28 June 2023
Risk Warnings
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.
