Investment trusts - does the discount / premium really matter?

7sefton

Hi everyone.

New-ish investor here.

I’ve been trading a few investment trusts recently and have read a lot about the NAV and how this creates a discount or premium vs the share price.

However I remain a bit perplexed about why this seems to matter so much: surely the only thing that matters is the share price itself?

e.g. If I buy some investment trust shares at a premium, then sell them when they rise in value, surely it’s irrelevant whether there is a discount or premium? Because all that matters is I’ve made money from my initial
investment?

I get the technical point that trusts allow you to effectively buy a basket of shares at a price that differs to their underlying value, but I don’t understand why so much attention is given to the this when the only thing that really matters (and drives a profit or loss) is the share price itself.

Am I missing something?!

Thanks in advance.

Prism

It depends on the trust but to me in general it doesn't matter. The share price of each holding is already an approximation of that companies true value. The share price of the trust is an approximation of the combination of those holdings. What you don't likely want to do however is take a risk on a trust that is currently on a large premium when its normally on a discount as there is a reasonable risk that it will switch back to that discount - assuming something fundamental hasn't changed about the trust.
REITs and infrastructure trusts are a little different as their NAV doesn't move about as much - its more about what you are willing to pay for a particular dividend yield and if you think that dividend is likely to drop or rise.

TemporaryUsernameMay2020

As Prism says, you should be aware of the risk of the discount/premium moving against you. Even if you sell at a profit, if that return is reduced by the discount widening or the premium disappearing, then perhaps you would have got a higher return by buying another similar trust, but one which started with a bigger discount or smaller premium, or buying an open-ended fund instead.

You should also be careful, when looking at the past performance of the trust, to separate out the NAV return from the effect of discount/premium expansion/contraction. For instance, if the share price has gone up partly because the trust moved to a smaller discount or a bigger premium, you can't expect that to continue indefinitely. The NAV performance is a better guide to what the underlying assets and the managers' skill (if any!) have achieved in the past.

Also, suppose (to keep it simple) that you buy a trust at a certain discount or premium, and when you eventually come to sell it, it has exactly the same discount or premium. In that case, does it even matter what the discount/premium is? Well, yes, if the trust has paid any dividends. You will have got more dividends (and hence a higher total return) if you bought and sold at a discount; and lower dividends (and lower total return) if you bought and sold at a premium.

Linton

I agree with Prism that it normally does not matter much.  If an investment meets your objectives then a few % premium/discount is not a major concern.  A large premium/discount may be worthy of further investigation - you do need to understand what you are buying.  In some cases, particularly with illiquid assets such as property, valuations are relatively infrequent so the premium/discount may not be particularly accurate anyway.

The ITs I hold tend to be rather more volatile than the underlying investments trading at a premium in the good times and a discount in the bad ones.  That may affect your decision as to whether to buy an IT or an equivakent OEIC/UT.

Aminatidi

I would look at some trust movements during recent events and thing how you'd approach it if you held them.
Rit Capital Partners swung really heavily from a premium to a big discount and bizarrely quite a few income trusts swung to pretty crazy premiums.
A lot of infrastructure saw large premiums disappear.
So I'm sure it can matter.
Let's not mention Lindsell Train Investment Trust

cloud_dog

No one really likes buying a IT when the SP is at a premium but, the other thing to assess is whether the premium has historically been at or around the level it is currently sat at.  Ignoring recent market fluctuations, if a IT has been at a 3% or 4% premium (historically) then I would feel comfortable investing.  If the same IT was currently trading at a 8% premium I may choose not to invest at present, waiting for the premium to return more to the 'norm' (the premium percentages are obviously relative).

george4064

In addition to the previous posters' good points, I do have a theory with discounts/premiums and thats when the actual trust's share price is low then I'm less concerned about the discount/premium than if its at a relative 'high' share price.

Not sure whether thats true for other investors, but if it was then we would tend to see discounts widen/premiums drop during bull markets and discounts come in/premiums rise during bear markets.

ColdIron

It matters inasmuch as the premium or discount can have a dramatic effect on the share price even when the NAV remains unchanged. As Prism notes this can be particularly apparent with REITs or infrastructure. Consider HICL. Between 18th Feb and 19th March a nearly 20% premium fell to an over 10% discount, consequently the share price tumbled from 183p to 137p while the NAV was broadly the same because nothing material had happened to the underlying investments. You will see a similar pattern with BCPT. For equities you could have a look at Nick Train's LTI over the last year

The premium or discount reflects investor sentiment going forward so it is a risk factor that you have to bear in mind which is absent with open ended funds which largely trade at NAV. It's a double edged sword that can work in your favour or against you

You could of course ignore it and focus solely on the share price but to do so would be to misunderstand what you have invested in and lead to unanticipated outcomes

John464

Discount is an embarrassment to the IT management because it shows the assets would be worth more if they were not in charge of them.  So they try to minimise the discount by marketing etc to create a demand.  But its not always their fault - usually they have just been unlucky with their recent choices, and their luck will return
I have done well out of Investment Trusts by buying when they are at a discount - because it shows there is value there that may be unlocked.  But it doesn't always work.  Sometimes the discount is high because the management is rubbish, and that doesn't change.  They might even get worse, then the discount widens.
But I'd rather buy at a discount than a Premium - because then you are depending on the management remaining better than average - and thats a big ask.
Nowadays I can't be bothered to do research, so stick with low cost index tracker ETFs

Albermarle

Discount is an embarrassment to the IT management because it shows the assets would be worth more if they were not in charge of them.  

I thought another reason for discounts for some IT's was that the NAV wasn't trusted/believed by the market , as some assets value can be open to opinion 

LHW99

Albermarle said:

Discount is an embarrassment to the IT management because it shows the assets would be worth more if they were not in charge of them.  

I thought another reason for discounts for some IT's was that the NAV wasn't trusted/believed by the market , as some assets value can be open to opinion 

I think Lindsell Train IT is a case in point here, as around half was invested in Linsell Train (the Company).