Investors need to understand the implications of discounts

This article is part of
Investment Trusts - May 2014

As investment trusts are bought and sold at their share price, investors would do well to understand discounts and premiums, and their implications.

A definition from the Association of Investment Companies (AIC) breaks it down into the share price, which is the price at which a company is bought or sold, and the net asset value per share (NAV).

The NAV is the value of all the trust’s assets, less any liabilities it has, and divided by the number of shares.

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The share price may be higher or lower than the NAV and this difference is known as a discount or premium.

For example, a trust with NAV per share of 100p and a share price of 110p is said to be trading at a premium of 10 per cent.

The average trust is currently trading on a discount of roughly 4.8 per cent but 27 per cent of the sector, excluding VCTs, is on a premium, according to the latest figures from the AIC.

The top four investment trusts trading on a premium are UK equity income trusts. JPMorgan Income and Growth is currently on a premium of 89.6 per cent, followed by Jupiter Dividend & Growth on a 63.4 per cent premium.

This is an indication of just how in demand income funds are due to their ability to deliver dividends and, therefore, long-term performance.

Many trusts in the infrastructure and property sector are also currently trading at a premium, including F&C Commercial Property on a 16.5 per cent premium and HICL Infrastructure which is at a premium of 15.4 per cent.

The AIC suggests many of the investment trusts on premiums are in sectors which are delivering income to investors and with “hard to replicate” strategies.

Investors seeking to buy an investment trust would be wise to familiarise themselves with whether it is trading on a discount or at a premium, although price alone should never be the only factor in the decision-making process.

When buying shares which are trading at a premium, the AIC advises that there needs to be a “good reason” for paying more than the NAV.

In other words, the investor believes there is a case for continued outperformance because if the shares move to a discount then this will only increase losses.

At this year’s AIC UK Conference for Directors in London, Charles Cade, head of investment companies research at Numis Securities, discussed how companies can prepare for a change in sentiment.

Mr Cade says: “I believe that boards seeking to grow their trusts by issuing shares at a premium should make a commitment to control discounts in future.

“This means that boards should have a clear buyback policy and stick to it.”

He adds: “We do not advocate that a ‘zero’ discount control is appropriate for all investment trusts, particularly for those with less liquid portfolios or cyclical mandates.