Investment Trusts risk query

luckylizard

Hi everyone, I've been wondering about using investment trusts in additon to my existing unit trusts and OEICS but there is one potential risk aspect that I don't fully understand about them and it never seems to be addressed in IT guides.

It's this: as ITs trade either at a discount or a premium to their NAV, does this mean that when you choose to sell part or all of your holding, you may also be forced to sell at a discount (or a premium) to the NAV, ie you get less (or more) than the actual value of your investment?

If that is the case, this seems to me to be a significant negative risk factor, and it's putting me off using ITs.

If anyone of you wise people could tell me if I'm right or wrong about this, I'd be very grateful!

Eco_Miser

You're right. This applies to all individual shares, but the NAVs are not usually known.

Look on the bright side, you could buy at a discount and sell at a premium.

kidmugsy

luckylizard wrote: »

you get less (or more) than the actual value of your investment

No, you get exactly the value of your investment. What you won't get is the value of the investments owned by the IT; you'll get either more or less.

luckylizard

Thanks both for replying - and therefore I'm wrong to consider this an 'additional' risk factor compared with a unit trust.

Thrugelmir

With Unit Trusts you suffer the risk of the fund manager having to sell stocks to fund redemptions.

With IT's the shares trade on the market so the fund manager is not forced to sell underlying investments.

Hence my preference for IT's. Particularly when investing in illiquid segments of the market.

Glen_Clark

You are right to consider it an additional risk factor. It really depends on the markets view of whether the managers are worth their fees. In most cases they don't think the managers are worth their fees so the trust trades at a discount - eg for every £100 worth of assets the trust holds the shares only cost £90 so a 10% discount. That discount could get bigger or smaller before you sell.

Its like buying a £100,000 house with an undesireable sitting tenant thats hard to get rid of, so you only pay £90,000 for the house - a 10% discount. If the tenant improves, or leaves and the house gets a better tenant, it could revert to full value or even above full value so you get £105,000 for the house - a 5% premium. But if the tenant gets worse you might only get £80,000 when you sell, - a 20% discount.

masonic

Glen_Clark wrote: »

Its like buying a £100,000 house with an undesireable sitting tenant thats hard to get rid of, so you only pay £90,000 for the house - a 10% discount. If the tenant improves, or leaves and the house gets a better tenant, it could revert to full value or even above full value so you get £105,000 for the house - a 5% premium. But if the tenant gets worse you might only get £80,000 when you sell, - a 20% discount.

Come on Glen, you forgot to mention the Government desperately throwing money at first time buyers to keep house prices rising, so even at a 20% discount, you'll still make a killing at the expense of the next generation

jimjames

luckylizard wrote: »

Thanks both for replying - and therefore I'm wrong to consider this an 'additional' risk factor compared with a unit trust.

No, you are correct, potentially it is an additional risk factor. But it does also have a benefit in a couple of ways. The discount can decrease which could boost returns, obviously the opposite could happen too so I'd never normally buy any IT at a premium.

Secondly and more importantly if you are buying at a discount you are getting the underlying assets (shares) at that discount. So a 10% discount means you are buying £1 of assets for 90p. That looks like a good deal to me as it means you get the performance of the £1 working for you and generating growth but at a cost of 90p.

As Thrugelmir points out there are also definite benefits when investing in illiquid investments such as private equity, property and emerging markets for example.

george4064

A few more key points on the ITs vs UTs argument;

- ITs are able to borrow (called gearing), this can enhance returns but also exacerbate losses, essentially adding risk but adds greater potential for higher returns.

- ITs can hold back income from the trust's underlying assets, this held back money can be used in tougher times to help smooth out income the IT pays out to shareholders.

- for many ISA platforms, ITs incur a smaller platform charge than UTs.

Thrugelmir

george4064 wrote: »

- ITs can hold back income from the trust's underlying assets, this held back money can be used in tougher times to help smooth out income the IT pays out to shareholders.

In reality this is reflected in the NAV of the trust so can be deceptive. when making comparisons. Dividend cover is in general falling. As is the case with a considerable number of companies. So has to be monitored as eventually there will be dividend cuts.

green_man

If you look at companies that run ITs and an equivalent fund you see that over the long run its almost always the IT that has the better performance (likely due to gearing use) but as said above it comes with slightly more risk attached. Some sites show how the discount/premium varies over time so you can avoid buying at a premium if you feel it may fall back to a discount.