Article 6 / 7
Guide to Investment TrustsPremiums, discounts and liquidity in investment trusts
The price of an investment company is set by investors, says Simon Moore, senior research analyst at Bestinvest, meaning it is determined in practice the balance of buyers’ and sellers’ perception of the future return from the share and its level of income.
If the investment company moves between a discount and a premium then this can add to volatility of returns for investors.
Investment trusts typically trade at a discount and the current average discount for the investment trust industry is around 7 per cent.
“Many prefer to buy at a discount and sell at a premium as this would give them better returns than if they had bought an identical portfolio as an ETF or open-ended fund,” says Mr Moore. “However for long term investors this effect diminishes over time.
“Currently investment companies that pay a good yield are in demand so trade at a level that makes the yield attractive compared to bonds – they do not trade by reference to the NAV,” he adds.
There are dangers of buying simply based on the perception that a trust is ‘good value’ as it is trading at a large discount to NAV, as there are likely to be some solid reasons for this.
Stephen Peters, investment trust analyst at Charles Stanley, says: “The discount doesn’t tell investors what is attractive or cheap and what is unattractive or expensive. It’s easy for investors to look at funds and see a 30 per cent discount and think that it’s really good value and I should buy it. But it’s not that easy.”
He stresses that like any investment decision, advisers should research the investment style, how the trust is being run, any problems that have led to the discount, and how much the trust is paying for leverage.
This latter point is particularly important, as a fund may be paying interest of 6 or 7 per cent a year on its leverage, when equity might be yielding 4 per cent.
“That leverage is costing you money, and can be a real hindrance if markets fall, as was seen in 2008.”
A lack of liquidity in the shares is another bugbear advisers cite, but Mr Peters argues it is “a moot point”.
“If I look at data right now on my computer I can see there are 44 trusts which trade more than half a million pounds a day. So for almost all trades by an adviser firm I’m sure it would not be a problem.”
The liquidity issues faced by a large wealth manager who might be trying to buy millions of pounds of shares in a single investment company is very different to clients looking to invest their Isa allowance for the year.
Mr Moore notes that it is easier to deal in large amounts for those investment companies with the largest market value and that “AIM-listed investment companies are particularly difficult to deal in”.
