Investment Trusts?

Audaxer

Sue58 wrote: »

I'm trying to get my head around the premiums/discounts.

As an example if a trust is trading at a 10% discount it enables you to buy £100 of asset for £90.00. However, when you come to sell if its still trading at a 10% discount there is no gain? You only gain if you sell at either a lower discount than 10% or hopefully if the trust hits a premium. Is my understanding correct?

The thing I don't really understand is that if an IT has moved from say a 5% discount when you bought it, to a 10% discount now, could the share price now still be higher than when you bought it? If the share price is higher than when you bought it, would you still have made a profit if you sold the IT despite the higher discount?

londoninvestor

Audaxer wrote: »

The thing I don't really understand is that if an IT has moved from say a 5% discount when you bought it, to a 10% discount now, could the share price now still be higher than when you bought it?

If the NAV has gone up by more than about 5.6%, then yes indeed!

atush

Discount and premium can be more to do with sector/market sentiment rather than an individual IT.

If people are looking for income, and that IT provides it- it is more likely to trade at a premium.

Audaxer

londoninvestor wrote: »

If the NAV has gone up by more than about 5.6%, then yes indeed!

Where does the 5.6% figure come from? I understand the discount is in relation to the NAV, but how is the share price related to the NAV?

JohnRo

Audaxer wrote: »

The thing I don't really understand is that if an IT has moved from say a 5% discount when you bought it, to a 10% discount now, could the share price now still be higher than when you bought it? If the share price is higher than when you bought it, would you still have made a profit if you sold the IT despite the higher discount?

Yes of course, if the NAV rises from 100 to 150 and the corresponding IT discount widens from 5% then to 10% now

ignoring transaction costs

purchase price was = 95
sale price is = 135 (+42%)

likewise the NAV could fall but a wide discount could simultaneously narrow to a point it offsets the NAV losses entirely, unlikely but entirely possible.

londoninvestor

Audaxer wrote: »

Where does the 5.6% figure come from? I understand the discount is in relation to the NAV, but how is the share price related to the NAV?

The discount is defined by:
Discount = 1 - (Share Price / NAV)

i.e. a 15% discount means that the Share Price is 0.85*NAV, and so on.

So in your example (buy at 5% discount, sell at 10% discount): let's say the NAV is X at the time when you buy, and Y when you sell.

Then the share price is 0.95X when you buy and 0.9Y when you sell.

That means that to break even (ignoring commission, stamp duty etc), you have Y/X = 0.95 / 0.9 ~ 1.056

i.e. you break even if the NAV is 5.6% greater when you sell than you buy - and obviously you profit if the NAV has risen by more than that.

ColdIron

Audaxer wrote: »

The thing I don't really understand is that if an IT has moved from say a 5% discount when you bought it, to a 10% discount now, could the share price now still be higher than when you bought it? If the share price is higher than when you bought it, would you still have made a profit if you sold the IT despite the higher discount?

Yes and yes

A discount or premium is not a real thing that someone imposes on a share. It's simply a measure of the difference, expressed as a percentage, between two things that are real, and can change independently. 1) The share price (what someone is willing to pay for them) and 2) the NAV (the actual value of the underlying holdings). A premium or discount cannot change in isolation, one or both of the two things above has to change. The NAV will change if the underlying investments change in value, all things being equal this will be reflected in the share price. Investor sentiment can change the share price without affecting the NAV. Both could change in the same or opposing directions

Using round figures and a fairly confected example for illustration: you buy £100 worth of underlying assets for £95, maybe because the market didn't have much confidence in the manager, this is expressed as a 5% discount. If the market then decides they won't pay more than £90 for his shares (maybe all the funds in the same sector go up and his don't) the NAV is unchanged so the discount becomes 10%. If his assets unexpectedly do well and the NAV goes up to £120 the share price might reasonably go up to £110 but potential investors won't pay more than that because they think he got lucky and can't repeat the performance. The shares are still trading at a (roughly) 10% discount but you sell the shares you bought at £95 for £110 - you have £15 profit

Audaxer

ColdIron wrote: »

Using round figures and a fairly confected example for illustration: you buy £100 worth of underlying assets for £95, maybe because the market didn't have much confidence in the manager, this is expressed as a 5% discount. If the market then decides they won't pay more than £90 for his shares (maybe all the funds in the same sector go up and his don't) the NAV is unchanged so the discount becomes 10%. If his assets unexpectedly do well and the NAV goes up to £120 the share price might reasonably go up to £110 but potential investors won't pay more than that because they think he got lucky and can't repeat the performance. The shares are still trading at a (roughly) 10% discount but you sell the shares you bought at £95 for £110 - you have £15 profit

Thanks, so if I wanted to invest in more ITs that fitted in with my portfolio, I would preferably buy at a discount or a small premium as it would be intended as a long term buy and hold investment. If I did consider selling at a later date I would only sell if the share price had risen since I bought it, but not be overly concerned what the NAV or discount/premium was at that stage. Does that make sense?

TBC15

If the agony and ecstasy of checking ones worth once a day doesn’t give you the buzz it used to then IT’s are for you. As long as the market is open so is the roller coaster.

ColdIron

Audaxer wrote: »

Thanks, so if I wanted to invest in more ITs that fitted in with my portfolio, I would preferably buy at a discount or a small premium as it would be intended as a long term buy and hold investment.

It's always nice to buy at a discount but you need to understand why and many good ones trade at a more or less permanent premium

If I did consider selling at a later date I would only sell if the share price had risen since I bought it, but not be overly concerned what the NAV or discount/premium was at that stage. Does that make sense?

Yes, it's the share price that matters to you at that stage. But unless you have a lot of flexibility, waiting for the share price to rise might be a luxury you can't afford. If it hadn't risen, or failed to match inflation, you might consider that a couple of decades of steady and reliable income was a good trade off. For myself I don't intend to sell down my income investments until I need someone to wipe the dribble from my chin. I'll worry about the absolute share price when that day arrives