Under the new regulatory regime, a lot of emphasis has been placed on investment trusts, particularly because independent advisers are required to understand all fund structures in the market.
Furthermore, with commission banned under the RDR, one of the incentives to recommend open-ended funds has been taken away, paving the way for renewed interest in closed-ended funds.
But because investment trusts are traded on the stock exchange, they come with a few quirks that don’t exist with Oeics and unit trusts. While open-ended funds always trade at net asset value (Nav), closed-ended funds do not, so sometimes there are better times to invest – often when the share price is trading at a discount. Here are a few tips on understanding what this means.
1. Know a few basics on discounts and premiums. Investments trust share prices move up and down in line with investor sentiment. When a fund’s share price matches the value of its underlying investments, or its Nav, it is trading at par. If the value of the shares in the market are trading for less than the fund’s Nav, it is trading at a discount. If the price is above Nav, it is trading at a premium.
2. Does the fund have a zero-discount policy? Lately the trend has been for funds to keep their discounts and premiums as close to par as possible by either offering share buy-backs when the discount is too large or issuing new shares if it trades at a significant premium. Such a policy can be a good thing, but only funds with sufficient capital and quality management can pull it off successfully.
3. Don’t be afraid of wider discounts. While some analysts believe discounts are a bad thing for the sector, they can be used to the investor’s advantage. Each investment sector has a different discount/premium range in which the funds trade. If a good fund is suddenly out of fashion but has strong management and an attractive portfolio, this can be an opportunity to invest. This was the case with listed private equity funds in the past few years when some saw their discounts to Nav widen to as much as 50 per cent.
4. Beware of the value trap. Not all discounts represent an opportunity, of course. Some funds will always trade below their Nav because they lack strong management and their assets are just not very compelling. While these funds might appear cheap, their share prices may never rise enough to provide a good return on investment. Conversely, a fund trading at a premium to Nav is not always a bad thing. Infrastructure funds often trade at a premium because they offer strong, long-term income yield.
5. Above all, make sure it meets the client’s objectives. There is no point recommending an investment trust if it does not match the client’s needs. It might be trading at an attractive discount or offer the prospect of high growth, but none of this matters if it is not suitable. Ultimately, the right fund is one that has strong management, quality underlying investments and solves a problem in the investment portfolio without adding unnecessary risk.
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