Many investors are unnerved by investment trust discounts and premiums. But the concepts involved are quite simple. And assuming you’re not – sensibly enough – a pure index fund investor1 – discounts and premiums shouldn’t put you off these interesting shares.
Equally, not understanding the difference between discounts and premiums can cost you money. It’s all too easy to be confused, as comments over the years on Monevator have revealed.
My previous articles on investment trusts should give you primer on the basics if you need it.
Today I’ll focus on discounts and premiums.
Investment trusts on sale
For active investors – or even ‘passive’ investors in the old-fashioned sense of buying and tucking away funds for the long-term – now could be a propitious time to look into these investment vehicles.
Recent data from the Association of Investment Companies (AIC) has 37 out of the 38 investment trust sectors trading at a discount:
“Since the beginning of the year the discount of the average investment company has widened more than 10 percentage points – from 3.6% on 31 December 2021 to 14.3% on 18 November 2022.
With almost all investment company sectors on a discount, the Association has published a list of average discounts across all equity and alternative sectors.
Out of 38 sectors, only the Hedge Funds sector trades at a premium, of 3.8%. The sector is one of this year’s best-performing, with several of its constituents delivering for investors in turbulent times, the AIC said.
The most deeply discounted equity sector is North America, on a 26.5% discount, followed by India on a 14.9% discount and Global Emerging Markets on 12.4%.
Among equity sectors, AIC figures show the biggest discount changes in 2022 have been in the Biotechnology & Healthcare and Technology & Media sectors, where discounts have widened by 9.2 and 8.5 percentage points respectively.”
As a naughty active investor (in contrast to my passive investing co-blogger) I love rummaging around in the investment trust bargain basement.
And as a long-time plunger in such markets, now feels like as good a time as any to get more than you paid for when you buy an investment trust.
But what exactly is a discount, and why should you pay attention?
Let’s start at the beginning.
What does your investment trust own?
We all (now) know that an investment trust is a company that purchases assets to hold or trade.
Such assets could include equities, property, bonds, or even exotic fare like farmland or art. The specific assets held will depend on the trust’s stated investment objective. (Or mandate, in the jargon.)
When we buy shares in a particular investment trust, we become part-owners in the trust. Effectively we then have part-ownership of those underlying assets.
Our slice of the pie depends on the percentage of the trust’s total shares outstanding that we own.
Most of us will only ever own a few thousand shares in an investment trust. But it’s the same principle, whether you hold 0.001% or 10% of the trust’s shares.
For example, equity income investment trusts own shares in large blue chip companies that pay healthy dividend yields.
As a shareholder in such a trust, you’ll typically be paid your proportion of the dividend income generated by those blue chip equities – minus the trust’s fees, hidden costs, and any income it retains for future use.
Equity income trusts appeal to active investors who want a diversified income. But as a shareholder, you’ll also benefit (or suffer) from the rise and fall in the value of the shares your trust owns.
Similarly, you might buy an investment trust that owns property or miners or bonds – or pretty much anything else you can think of.
You might even buy an investment trust because you hope think the manager is an especially skilled one.
They may be fishing from the same general pool of shares you could buy for yourself – or that you could invest in via a tracker fund – but you may believe the trust’s manager is more skillful at picking winners. And so you hope their trust will beat the market.
Net assets
In any case, the trust will own a lot of stuff, which are called its assets.
The trust may also have debt (also known as gearing). These borrowings would need to be repaid out of assets if the trust were ever to be wound up, before its owners (the trust’s shareholders) could divide whatever was left.
Therefore:
Net asset value (NAV) = Total trust assets minus any debt
How to calculate the net asset value per share
While they amount to the same thing, it’s often easier to think about what portion of the trust’s net assets each individual share is theoretically entitled to, rather to work off the whole trust’s market value.
Let’s consider an example.
Imagine the world’s simplest investment trust, Monevator Investments PLC.
This recklessly mismanaged operation owns shares in just two companies, TI Corp and TA Inc. (Hey, it’s good to hedge your bets!)
Let’s say shares in TI Corp are trading at £10 and TA Inc is at £12, and that the trust owns 100,000 shares of TI Corp, and 50,000 shares of TA Inc.
The trust’s TI Corp holding is worth £10 x 100,000 = £1 million
Its TA Inc holding is worth £12 x 50,000 = £600,000
The Monevator trust has zero debts.
Therefore, the net assets of Monevator Investments PLC is £1.6 million.
Now, let’s say this trust has one million shares in issue.
Net assets per share = £1.6 million / 1 million = 160p per share.
Each share is effectively a claim on 160p worth of assets owned by Monevator Investments.
So far so simple!
Investment trust share price versus NAV
Any share is worth whatever someone will pay for it. There’s no right or wrong value for any particular share that you can calculate with a formula – in the sense that whatever value you come up with, it’s irrelevant if nobody will pay that for it today.
This is why share prices are so volatile. The market is constantly trying to agree upon the correct value of every company.
Consider a giant drug maker like GlaxoSmithKline. Calculating its ‘correct’ valuation is likely impossible. There are many brands, new ventures, potential disasters and expired patients patents that can impact its profits from quarter-to-quarter.
Fluctuating sentiment also continually alters the multiple (the P/E ratio) that investors are prepared to pay for a claim on Glaxo’s profits.
Over the long-term our valuation estimate might prove to be approximately right. But in the short-term it’ll be precisely wrong – except by luck.
In contrast we can immediately see what a Glaxo share is worth right now by pulling up its share price on the Internet.
You might believe GlaxoSmithKline is worth £20 a share. But as I type this the market says it’s worth £14.55. That’s what someone will pay for its shares right now.
If you’re confident you’re right, you might buy Glaxo shares as they’re trading for less than your valuation and wait for the market to come around to your thinking. (That, in a nutshell, is stockpicking. But that’s for another day…)
Investment trust valuation is a little different
With an investment trust like Monevator Investments PLC, it’s usually very easy to work out its value. You simply look at its assets and debts, calculate the NAV like we did above, and hey presto – you’ve got its value.
This is true of any investment trust that holds a basket of liquid and quoted securities, where you can just call up the latest price of each investment. (I’m ignoring for now more complicated trusts that invest in unquoted or illiquid assets).
You don’t even have to calculate the NAV per share, unless you want to double-check something. Resources like the AIC’s website collates the stats for you. Trusts also regularly publish their NAVs via the London Stock Exchange’s RNS service.
Now before anyone objects, it’s true that the listed securities owned by the trust might be worth more or less than what the market is pricing them at today, and hence what’s reflected in the NAV.
That takes us back to the Glaxo discussion we just had.
But the point is a trust could in theory dump all its Glaxo shares at today’s market price.2 And that by doing so for all its holdings and then paying off the debt, it would (after costs) be left with that NAV in cash.
In other words, for mainstream investment trusts the NAV is not subjective or an opinion. It’s a fact.
Discounts, premiums, and NAVs
Despite this certainty, it’s often the case that the share price of an investment trust trades at less than its NAV per share.
And this may be an opportunity. Price is what you pay but value is what you get, to quote Warren Buffett.
For instance, Monevator Investments may trade for £1.20 a share, despite anyone with a calculator being able to see its NAV per share is £1.60.
So in this case, a buyer is getting £1.60 of underlying assets for just £1.20.
Bargain! The share is trading at a discount to NAV:
The discount is (£1.60-£1.20)/£1.60 = 25%
The general idea is that you get more for your money when you invest at a discount. Hopefully in time the discount will narrow, pulling the share price up towards the NAV and amplifying your returns.
Note there’s no guarantee this will happen though. (If there was, discounts probably wouldn’t exist.)
Sometimes trusts can languish on discounts indefinitely. Trusts may even be wound-up as a consequence. Doing so almost always closes the discount, but it typically comes after a period where whatever caused the discount (lousy returns, say) have already done a bit of damage.
Discounts can also be great for income investors who buy and hold, since the money you spend on your shares buys you more of the trust’s income generating assets.
For example, suppose a trust trading at £1 per share – the same as its NAV of 100p – owns a portfolio of blue chips that generates a 3% yield. If the share price falls to 90p to create a 10% discount to an unchanged NAV, then new buyers will enjoy a higher 3.33% yield from the trust. (That is, 100/90*3).
Premium pricing
Less often you’ll find a trust priced greater than its NAV. This is more common in bull markets, or for a popular new launch.
For instance let’s say Monevator Investments is trading at £1.80. Net assets are still £1.60 per share.
Then the premium is (£1.80-£1.60)/£1.60 = 12.5%
Now you’re paying 12.5% above what the shares would be worth if everything was sold tomorrow.
Probably not such a good deal!
Also, what I said above about discounts boosting your income is countered with premiums. They reduce the yield from the trust’s underlying investments.
Paying premiums can be costly
For one very illuminating example, when I wrote the first version of this article in 2014 Fundsmith’s then-new emerging market trust traded at a premium to NAV. This was despite its initial assets being merely cash.
You were paying, say, £1.05 to buy £1.
People wanted to own the shares as a bet that fund manager Terry Smith’s stock picking prowess would extend to emerging markets. However that didn’t really pan out, the shares slipped to a discount, and in 2022 the trust was wound up.
So beware hype and premiums kids!
For another example, popular fund manager Nick Train’s Lindsell Train investment trust was trading at a premium of nearly 100% a few years ago.
In that instance investors were betting that the NAV was misstated. This line of thinking was possible because Lindsell Train’s largest asset is a holding in Train’s own investment company, also called Lindsell Train.
With unlisted investments like that, the pricing certainty I talked about doesn’t hold. (This is most commonly seen with private and venture capital trusts.) Hence you can’t be sure of the NAV.
To his credit, Train repeatedly warned investors they were probably paying too much for the trust’s shares. And for the record the share price has halved since those days. Indeed last month you could even buy the shares at a discount.
Sometimes a small premium is the price of entry to a very popular trust, particularly one that has some kind of discount control mechanism allied to its strong appeal.
For instance, Capital Gearing Trust is usually priced just over NAV.
More egregiously, infrastructure trusts have tended to trade at double-digit premiums, although this year these have finally collapsed as bond yields have risen, reducing their relative attractiveness.
Personally I’d never pay more than a couple of percent as a premium. And then only very rarely.
A few final tips on discounts and premiums
Here’s a few things you may be wondering about – or that maybe you should be wondering about if you’re not:
- Fund factsheets and data suppliers usually give the discount or premium as a percentage figure.
- Typically a negative number – for example -5% or (5%) – indicates the level of discount to NAV.
- In contrast a positive percentage indicates a premium to NAV.
- As mentioned, investment trusts must release regular RNS press releases to the stock market. You can find these on various websites. I always check these for the latest NAV per share, and I do the discount/premium calculations for myself. Sometimes the online data sources and factsheets are out of date.
- Another reason to check is that different data suppliers often treat debt and accrued income differently in their calculations. (For example, one may count debt on the balance sheet at its face value, while another calculates its impact on NAV based on what it would cost to pay off the debt today).
- Why do investment trusts trade at discounts? And why on Earth would anyone pay more for a trust than its assets are worth? Great questions, that I’ve previously attempted to answer.
Opportunity knocks
The whole discounts and premiums malarkey was often pinned by old-school Independent Financial Advisers as the reason they put their customers’ money into unit trusts rather than investment trusts.
Clients were too easily confused, they said. (“Honest guv, nothing to do with the commission that unit trusts kicked back, but investment trusts could not…“)
Yet confusion, panic, and mispricing can be your friend if you’re involved in the quixotic (and generally ill-advised) game of active investing.
To that end, I think investment trusts and their mercurial discounts offer a dedicated active investor an interesting halfway house between open-ended funds and ETFs and the outright stockpicking of single company shares.
And after a long sell-off in shares that have hit investment trusts pretty hard, discounts abound.
If you’re an active investor for your sins, happy hunting!
- Investment trusts are companies that invest in other companies, so in effect they are actively managed funds. Passive index fund investors prefer the warm comfort of low fees and getting the market return to the potential (but in practice rare) upside from active management. They’d therefore choose trackers and ETFs over investment trusts. [↩]
- In practice this might move the share price if it owned a lot relative to the company’s outstanding share count. Again: details! [↩]
A lovely summary of the investment trusts. The premium/discount stuff seems to make ITs more attractive in points of market turmoil. I’ve only ever bought them when the heat was on. And I still have all of them.
And indeed I still have reason to be grateful for Monevator striking a light in the dark days of the Spring 2009 when it looked like all would fall. And I came across this article. And took appropriate action – I didn’t have a HYP to sell but I wanted one. and ITs made that cheaper to have at the time, plus some instant diversification.
There’s a rough-and-ready calculation I find handy. Suppose Monevator Investments trades at a 10% discount and holds shares that themselves yield 3% p.a. Then the buyer gets approx a 3.33% p.a. yield. Except that you have to subtract charges. Say those are 0.5% p.a.: then he gets 2.83% p.a. yield. Compared with what the underlying shares yield, it’s as if he got the 3% p.a. with o.17% p.a. subtracted in charges. Which means that it’s almost as cheap as some ETFs or index-tracking mutuals.
You then have to ask what MI does that justifies that charge. For some people the income-smoothing might justify at least part of that. Or the ability to gear.
Mind you, I’d be happier if I understood how the tax works on these things.
@dearieme — Good reminder about yield, it’s been so long since it’s been a factor for equity income trusts due to the mania for dividends for the past few years that it slipped my mind to include it! 🙂 Have added a note about the yield-enhancing attractions of a discount to the article.
@ermine — Thanks very much, I know you’ve long been a fan of investment trusts. There’s usually an unpopular sector somewhere — for example emerging market trusts at the tail end of last year. Of course there’s no guarantee that buying on a discount will lead to profits. Sometimes the market may be correctly anticipating trouble ahead, or poor value-destroying management. As ever, there’s an element of judgement (/luck) involved.
The other thing to bear in mind with investment trusts is how often the stated net asset value is updated
With big trusts investing in liquid quoted stocks this will usually be daily
But some big trusts like RIT only update their net asset values monthly
Once you are getting into smaller trusts investing in smaller companies the net asset value is only going to get updated 4/5 times a year
Then you need to look at how the assets are being valued, easy enough if they are publicly traded but not so easy its non-quoted equity and debt investments in companies
Also you need to look at the debt that investment trusts are using….many trusts issued long term debts instruments many years ago so they are now paying near double digit interest rates on their debt which will drag down their returns
Investment trusts can be very complex and unless they trade at significant discounts (20%+ was not uncommon in the past) I’m not sure that the complexity is worth it in a world where low cost etfs are available
This morning’s paper reports that an Invesco property trust seems to be bust, with the shareholders to expect nothing back. They seem to have geared with appalling timing.
hi , is an AMC of 1% ish too expensive for an investment trust or would I be better sticking to a tracker fund?
from what ive found JP Morgan European income IT [JETI] is on a discount of about -8% at present and im looking for exposure to Europe and was considering vanguard Europe ex uk tracker fund. but then I found this IT.
any thoughts ?
Anything particularly catching your eye @TI ?
Personally I find the extent of the big UK listed private equity trust discounts bizarre.
e.g. Pantheon International at c.45% or Harbourvest Global PE c.47%
*IF* the NAV was accurate and *IF* they had boards who acted in the interest of shareholders why wouldn’t the trust buy back all the shares they possibly could? The return on the cash allocated to the buyback would be almost 100%.
The only one with a vaguely shareholder friendly approach (IMO) is Apax Global Alpha given a policy to distribute 5% of NAV in dividends annually. It’s constantly chipping away at the discount.
Monstrously egregious and opaque fee structures, high leverage and highly questionable NAVs notwithstanding the extent of the discounts are eye catching and in fairness recent asset sales have been at or above NAV in many cases.
When good old Scottish Mortgage dipped to a 10-15% discount this year it seemed a decent long term entry point.
I’m a fan of Investment Trusts, using some for preservation (3 of the usual suspects) and others for their income (AIC’s Dividend Heroes – both generations). I am not in any way an expert and faced 2 issues with NAV figures when choosing which ones to invest in. First is that the NAV figure can be a little out of date as some IT update it frequently others less so, and that can impact the discount/premium quoted figure or your own calculation. Second, whilst the typical “minus is a discount, positive is a premium” advice above is valid, it isn’t always so easy to understand on some of the websites.
@AoL — A lot is catching my eye, as always in sell-offs things get more interesting! 🙂 I agree that private equity trusts are glinting especially fervently. But the increasing vogue for holding unlisted assets means that even the likes of the big Baillie Gifford tech trusts are ‘infected’ (!) by the fear about the valuation of their unlisted holdings. (Worth noting that much of their unlisted stuff is ‘preferred’ incidentally…)
I’m also increasingly intrigued by big UK generalist property REITs, where some really catastrophic outcomes seem to be being priced in (perhaps possible, given the speed and extent of the move in rates, and the clumsy way in which some management teams seem to have responded…but still…)
But this hardly covers it. There’s either a lot of value around or we’re in for a whalloping. 🙂
@MarkR — I find RNS on the LSE the best resource. Often some of the other data providers (including one I pay for!) don’t feature all RNS. (Click ‘more news’ or similar on LSE even when you think you’re seeing the latest RNS).
Some factsheets you’ll find on certain sites can be literally years out of date. (Perhaps it depends on whether the trusts pay a fee or not to the service provider. It’s not clear always).
I also feel bullish about UK REITs, given the massive drops in share price. NAV always lags behind, so I take the ‘discounts’ with a pinch of salt. Surely there’s more NAV pain to come, reading the latest RNSs. But at a low 15-25% LTV, fixed rates for 7-10 years, and fully covered dividends yielding 7%, makes you wonder how much more downside there’s to it. Obviously, tenants can go bust, and it can get worse than expected. But as always, the job of the investor is not to avoid risk, is to get compensated for taking it.
Just realised I paraphrased your ‘increasingly intrigued’ with ‘bullish’. Oops!
@Foxy — Yes indeed, it’s hard to be certifiably ‘bullish’ at the moment given (a) imminent recession (b) rates still rising (c) entire commercial property sector has been subsisting on ultra-low rates for the better part of 15 years and yet never really recovered after the 08/09 downturn (d) skeletons in the closet due to (c) too (e) huge uncertainty about structural changes post-Covid/lockdown revelations (f) Brexit as a lingering drag… I could even go on.
But the scale of the sell-off is definitely intriguing, particularly the recency of it. I wonder if the pension fund kerfuffles around the Mini Budget caused some forced selling / repricing at the margins. In theory no (they had to sell liquid gilts, that was the crisis) but then again did their tumult cause other players to sell off assets further up the curve, such as commercial property? If so there might yet be an extra 10% margin of (sort of) safety in the price.
I’ve nibbled, and may add a bit more. Can’t see me going above 5% though, FWIW, given the vast and potentially existential uncertainties.
No forced selling in commercial property to my knowledge. Also these REITs are closed ended so no forced selling to meet redemptions either. The market sentiment worsened after the mini budget but UK REITs had been suffering way before we shot ourselves in the foot.
Also the price declines happened so quicky. It was a case of “sell first ask questions later”.
@Foxy — I mostly meant the funds/trusts/other vehicles (not necessarily the retail investor ones) as opposed to the underlying, but with that said I have heard of distressed investors looking to get out at a time not of their choosing. (‘Forced’ for the underlying would be too strong, agreed, as far as I have seen).
e.g. https://www.bloomberg.com/news/articles/2022-10-18/property-funds-start-selling-assets-to-help-stricken-pensions
@TI (#14):
I think there is some way to go until the full consequences of the recent leveraged LDI debacle are widely known/understood. IIRC you recently highlighted a couple of quotes from Tapper, et al on this subject. For info, the full evidence session – at a tad over two hours, along with a handy downloadable transcript, is available from:
https://committees.parliament.uk/event/15694/formal-meeting-oral-evidence-session/
It’s worth remembering that a fund can remain discounted longer than you can remain contented!
What’s the point of Investment Trusts that have 0.5% stamp duty, whereas ETFs don’t have this fee? Shouldn’t all active and passive managed funds be ETFs only?
On REITs, discount to NAV can be misleading given leverage. Discount to GAV (i.e. enterprise value vs reported property value) is more helpful to understand what discount you actually acquire the properties for. The highest levered REITs will show the largest NAV discounts but this is a lower GAV discount given all the debt ahead of you is not discounted.
Even more useful is to take the latest rent divided by the enterprise value to get the implied yield on the property.
TR Property is interesting. It’s an investment trust that owns REIT shares but itself is trading at a discount to NAV. You therefore get a double discount (i.e. TR is at a discount and the shares it owns are at a discount).
@#16 GFF – The share price can increase even if discount to NAV remains the same or even increases (e.g. if rents increase or valuation yields decrease).
Great article as normal, check out this free EBook for investment trusts for 2023
https://harriman-house.com/ithb2023?mc_cid=311368af68
link was from lemonfool on their Investment Trust section
In the case of property and private assets, how certain are you that the valuations driving the NAV are accurate? I’ve certainly been burned in the past, so these discounts could reflect sizeable revaluations coming down the pipe. This applies to any income vs EV analysis as well: have you stress tested your assumptions with a 20, 30, 40% income shock?
At least with public equity underlyings you’ve got a daily NAV that’s somewhat rooted in reality. I know too much of how the sausage is made on the private side to be entirely comfortable.
@mr_jetlag — Not sure if you’re asking me or another poster? 🙂 But for my part I’m never ‘certain’ about any investment, and indeed I’d purge that word from your investing lexicon… 😉
(Unless perhaps you’re using it in the way the dodgy hedge funders in the TV show Billions use it as code for insider trading insights. Nefarious hedgie #1: “How confident are you about this thesis?” Nefarious hedge #2 who has the insider info: “I am not uncertain.”)
Regarding property NAVs and private equity trusts, of course they can reflect sizeable revaluations, as I mentioned in my comment. I’m intrigued, not certain.
With that said it’s always important to think what’s priced in. Right now you’re getting 25-60% discounts on some of these NAVs. The market is surely right to mark them down; the judgement is how right? Too much or too little?
Compare that to a couple of years ago, when you often might have had to pay a premium.
Did investors buying, say, Pantheon on a premium in 2019 have certain knowledge about the future to justify the premium they paid? Were they offered some kind of money back guarantee if the NAV or share price went south?
Clearly not, yet both happened at some point in the months afterwards (though very modestly so far — it’s more in this case that the discount has widened).
I’m not being facetious but trying to make a make, which is that the future is *always* uncertain, one way or another. Sometimes you at least get a discount on that uncertainty, and yes as you rightly point out very often that might be because some kind of falls are all-but nailed-on, and this is now a *known* thing.
But the truth is (a) it was always uncertain and (b) better than expected things can happen too. 🙂
Looking at premiums and discounts shows if there is a wider buying or selling opportunity even if investing passively.
This may be a great opportunity to hunker down for a few months and aggressively save as you are buying when the markets are low.
Whatever you think it’s a great idea to see where sentiment is. But when people are fearful and sell when they are confident.