High premium IT’s

Stargunner

I read in Investors Chronicle at the weekend that Pacific Horizon (PHI) has been trading at a very large premium to net assets of 16% following an outstanding performance. The article advised that investors should be aware that shares bought at a high premium can quickly lose substantial value if the premium is eroded. 

Since I read that article I notice that PHI share price has been dropping about 3% every day and is around 15% down in a week that has been a positive week for most other IT’s/funds.
On HL today it shows the premium as 8% and on Fidelity it shows as 4%. 

I was just curious as to is the reason for the decline this week that they are reducing their premium and what is the reason that  IT’s have these premiums.

Alexland

Stargunner said:

I was just curious as to is the reason for the decline this week that they are reducing their premium and what is the reason that  IT’s have these premiums.

Although the trust can take some actions to control their premiums (such as issuing new shares) it's generally a reflection that those publicly trading the trust shares on the stock market are willing to pay a higher (or lower) value than the underlying net asset value because they think the manager is likely to do well (or badly) in the future. The same market forces that drive up and down individual company shares. Short term premiums can develop if a trust gets positive news coverage with the right readers who go out and try and buy some shares.

Similar to how investors can make the mistake of buying high and selling low the same can happen on trusts where they buy at a premium then sell at a discount. One of the advantages of buying into a trust is that it is possible to buy at a discount to the NAV if the manager is out of favour (or there are too many people wanting to sell at once). I wouldn't mind buying into a good trust at a slight premium but once it gets beyond a few percent you really have to question if it would ever be worth it as you are risking the double whammy of the investment strategy underperforming damaging both the premium and NAV causing a collapse in the share price.

cloud_dog

They, the IT company, do not control the premium (1), the premium, or discount is aa s result of demand to buy or sell.

All companies listed experience this, as the company holds assets or investments with a value of X but depending if there is demand the sum of the shares in issue x the share price will give a value of Y.

(1) Some ITs will have a stated mandate to keep the premium below a certain level but even then they cannot simply 'set' the premium.

Stargunner

Thanks for your explanations. I notice that some IT’s are at a premium and some at a discount. I suppose they discount the poorer performing ones to try to encourage investors to buy them. 

AlanP_2

Stargunner said:

Thanks for your explanations. I notice that some IT’s are at a premium and some at a discount. I suppose they discount the poorer performing ones to try to encourage investors to buy them. 

Who is the "they" in your statement?

The market participants take a view on what a share is worth to them and offer to buy / sell based on their conviction, that sets the published price.

So if you want to sell your shares in an IT and there are a lack of buyers interested, then yes, you would need to lower your asking price which could lead to a discunt compared to NAV.

The undetrlying assets have a Net Asset Value, at times they are out of sync.

The IT Manager / Board will not want their share price to be below NAV as that is "punishing" their investors if they have to sell. How would you feel if the "policy" was to encourage a discount and thus make your investment worth less?

cloud_dog

Stargunner said:

Thanks for your explanations. I notice that some IT’s are at a premium and some at a discount. I suppose they discount the poorer performing ones to try to encourage investors to buy them. 

As AlanP_2 mentions there is no 'they', unless you are using it to refer to many ITs.

Some ITs by the nature of their investment may have a discount, and this discount may be relatively stable.  This can occur where an IT holds illiquid assets, for example property or private equity.  The premium/discount number in isolation of everything else does not give the whole picture, you need to understand what you are analysing and place it in context.

ITs are considered more risky for novice investors because of this (and a few other reasons I won't get in to here).  Perhaps ITs are not for you?

csgohan4

Don't buy IT's based on premiums nor on discount alone. Research the IT and make a judgement from there. Take SMT as an example traded at a premium but did very well this year. if you didn't want to buy because it had a high premium, you would have lost out on the 50% gain if you bought at 800p

Stargunner

Thanks for your replies and sorry I used the word they in the wrong text. I do invest in some IT’s and have never been put off by the premiums. I research what they invest in and how they have performed, although I appreciate past performance is no guarantee of future performance. I do hold SMT which as you say has performed very well.

Alexland

AlanP_2 said:

The IT Manager / Board will not want their share price to be below NAV as that is "punishing" their investors if they have to sell. How would you feel if the "policy" was to encourage a discount and thus make your investment worth less?

The use of share buybacks to reduce the discount is the board's decision and one of the areas they can add value outside the fund manager who works the underlying asset portfolio. The board has to balance their primary responsibility to existing shareholders with the knowledge that some of the prospective buyers are actually the same investors reinvesting dividends and the ambition to grow the size of the trust (by issuing new shares) so that the trust's costs can be better spread across more shareholders. The discount can even affect the ability of the board to attract high quality new board members. It's all a fine balance but it seems when the discount is over 10% in normal market conditions something has to be done about it. If the trust keeps needing to execute buybacks to limit the discount then the board might even consider replacing the manager.

Stargunner said:

I do invest in some IT’s and have never been put off by the premiums.

On some trusts I would definitely be put off by the premiums as potential speculative bubbles.

Eco_Miser

AlanP_2 said:

The IT Manager / Board will not want their share price to be below NAV as that is "punishing" their investors if they have to sell. How would you feel if the "policy" was to encourage a discount and thus make your investment worth less?

I wouldn't want a premium to drop to a discount, but if I could buy at a discount that would be a good thing, getting a greater value of assets than I paid.

For this reason some boards will indeed have a policy to maintain a small discount - it makes their shares look cheap and therefore attracts buyers.

bowlhead99

Alexland said:
 It's all a fine balance but it seems when the discount is over 10% in normal market conditions something has to be done about it. If the trust keeps needing to execute buybacks to limit the discount then the board might even consider replacing the manager.

You do tend to see some types of trusts or investment companies on long term discounts though, e.g. those operating in illiquid sectors such as private equity or with particular types of holdings.

So private equity funds-of-funds for example like Harbourvest (HVPE) or Pantheon International (PIN) are generally not going to be under 10%. The market discounts the 'fair value' NAV for illiquidity because the trust could not get its money back tomorrow at the declared value, it might take years; and there is a risk of the trust having its own liquidity problems in meeting unfunded commmitments to investees which could cause it to need to offload assets in a fire sale (or raise new money in the market) to get the capital to meet funding obligations or make important follow-on investments to preserve the value in the underlying investee holdings.

In such cases, 30%+ might be an attractive discount caused by rocky market conditions (e.g. 2009 or this March) while 15-25% be more of a normal mundane one rather than exceptional, and a mere 5% unheard of.