Is investment trust arbitrage a real strategy?

benbay001

I just pulled up Scottish Mortgage IT on HL to see how much of a battering it has taking over the last months and see its gone from trading at a positive 5% premium to NAV to a 10% discount to NAV within 6 months. 

Surely, assuming efficient market hypothesis meaning the market value of the underlying assets represents all publicly known information on the stocks held, why wouldnt the discount be narrowed by the same people who play arbitrage in other markets?

Disclaimer, i have no intention of trying the strategy, least of all on SMT.

Tia

bd10

While I cannot comment on the specific case of SMT (or other trusts from the same staple or even FGT ...) I'd say that yes, some fund managers have been and are playing the premium/discount game of IT's such as Peter Spiller & team of CG Asset. He said so last year (or so, time flies) when they bought BBOX at a very healthy discount to NAV right in Q1/2020.

wmb194

benbay001 said:

I just pulled up Scottish Mortgage IT on HL to see how much of a battering it has taking over the last months and see its gone from trading at a positive 5% premium to NAV to a 10% discount to NAV within 6 months. 

Surely, assuming efficient market hypothesis meaning the market value of the underlying assets represents all publicly known information on the stocks held, why wouldnt the discount be narrowed by the same people who play arbitrage in other markets?

Disclaimer, i have no intention of trying the strategy, least of all on SMT.

Tia

Yes, you can, particularly at times of volatility. One trust I follow usually trades at a 10% discount but when it recently widened to 15% without any obvious underlying cause - I try to keep track of its portfolio - I snapped up more of its shares and it duly narrowed again to 10% and I took my profit. Not a low risk strategy and you need to think hard about what they own and where those shares/assets might be going plus there can be an element of 'star manager' fashion investing and chasing performance - as has been the case with SMT and pushes trusts to premiums - but it can work if you're patient and observant. It helps if it invests in shares/assets that you're happy to hold and hope with anyway.

10% discounts are common when the market is unhappy so I'd be reluctant to assume any imminent return to 'normal' for SMT, and particularly as its star manager recently left.

NedS

I view the discount as the market's perception of where the valuations of the underlying assets are heading. Why would I want to pay NAV for something I think is likely to drop another 10% from here - hence the discount.

Private Equity often trades on even wider discounts where NAVs are only updated maybe every 3 months, and were popular trades last year as discounts narrowed in the rising market. No doubt they will overshoot the bottom and be slow to narrow at any reversal, but I don't think we are there yet.

JohnWinder

If there is an arbitrage opportunity, a chance to buy and sell equivalent assets at the same time to take advantage of different pricing, it won’t be one you or I can take advantage of since we can’t buy shares in the trust at a discount and then liquidate those to their component parts which we then sell. But could trust managers buy their own shares at a discount and then liquidate the assets for profit and pleasure?

  Yes, you can, particularly at times of volatility. One trust I follow usually trades at a 10% discount but when it recently widened to 15% without any obvious underlying cause - I try to keep track of its portfolio - I snapped up more of its shares and it duly narrowed again to 10% and I took my profit. Not a low risk strategy

I don’t think that’s called arbitrage. That’s called market timing or speculating on a change in value, as you suggest by noting it’s not low risk. Arbitrage is low risk I think.

george4064

Just to add another angle on things; often a trust will swing to a discount when the trust price (and probably the market in general) is riding high and vice versa (so swing to a premium or discount will narrow) when it’s riding low.

Reason behind this theory is that when stocks are more expensive people will less willing to buy them (and more bothered about the discount/premium) so a discount may form, whereas when the market has recently tanked you’ll get many people buying at whatever discount/premium because they know they’re buying in at a lower price than it was, therefore pushing the trust’s share price up vs the NAV.

I guess the point I’m making is that it can sometimes be a bit of a false economy, if what I described above ever happens, even only slightly,

adindas

benbay001 said:

I just pulled up Scottish Mortgage IT on HL to see how much of a battering it has taking over the last months and see its gone from trading at a positive 5% premium to NAV to a 10% discount to NAV within 6 months. 

Surely, assuming efficient market hypothesis meaning the market value of the underlying assets represents all publicly known information on the stocks held, why wouldnt the discount be narrowed by the same people who play arbitrage in other markets?

Disclaimer, i have no intention of trying the strategy, least of all on SMT.
Tia

What you said is not an arbitrage but probability game. You are likely to get a better chance to make better profit when you buy below the NAV value then those who buy it above the NAV value or blindly buy at any price.

According to the Efficient Market Hypothesis (EMH), stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices.

This is woefully wrong in some occasions during particular period especially during the bear market, a lot of FUD (fear, uncertainty and doubt) a stock could fall far below their NAV in the short, medium term, below 15 years (say).

You could just see now in the current bear marlet, there are already many high quality funds/stocks have fallen beyond their NAV/fair values.

Also keep in mind NAV, fairt value is not static, it is an estimated value based on the current condition. Noone could predict the future with 100% degree of confidence.

In the stock market there is another factor that can not be incorporated in estimating the NAV value, e.g. Exuberance. You will never know it China invade Taiwan, when there as a black swan event, FUD leading to panic selling and panic buying.

An acute investors like Warren Buffet along with other Hedge Funds Managers, acute Traders, contrarian do not believe in the Efficient Market Hypothesis (EMH). They time the market waiting until the funds/ stocks fall below the NAV/ fair value and using technical analysis, fundamental analysis, current news before they strike.

Also a quote from Keynesian economics the study of supply and demand, how economies - markets and other systems that operate on a large scale - behave, the reason why not just rely on NAV/fair value.

Albermarle

george4064 said:

Just to add another angle on things; often a trust will swing to a discount when the trust price (and probably the market in general) is riding high and vice versa (so swing to a premium or discount will narrow) when it’s riding low.

Reason behind this theory is that when stocks are more expensive people will less willing to buy them (and more bothered about the discount/premium) so a discount may form, whereas when the market has recently tanked you’ll get many people buying at whatever discount/premium because they know they’re buying in at a lower price than it was, therefore pushing the trust’s share price up vs the NAV.

I guess the point I’m making is that it can sometimes be a bit of a false economy, if what I described above ever happens, even only slightly,

I can not say I have ever studied it in detail and am not an expert at all, but I had the impression that when the markets dives, the higher risk level IT's dive even more, for a short period anyway. In other words they overshoot the market movement and a bigger discount/smaller premium opens up for a while.
Maybe that only applied to the ones I follow though.

Prism

Albermarle said:

george4064 said:

Just to add another angle on things; often a trust will swing to a discount when the trust price (and probably the market in general) is riding high and vice versa (so swing to a premium or discount will narrow) when it’s riding low.

Reason behind this theory is that when stocks are more expensive people will less willing to buy them (and more bothered about the discount/premium) so a discount may form, whereas when the market has recently tanked you’ll get many people buying at whatever discount/premium because they know they’re buying in at a lower price than it was, therefore pushing the trust’s share price up vs the NAV.

I guess the point I’m making is that it can sometimes be a bit of a false economy, if what I described above ever happens, even only slightly,

I can not say I have ever studied it in detail and am not an expert at all, but I had the impression that when the markets dives, the higher risk level IT's dive even more, for a short period anyway. In other words they overshoot the market movement and a bigger discount/smaller premium opens up for a while.
Maybe that only applied to the ones I follow though.

I would say that certainly seems true. I hold the Chrysalis IT which invests mostly in private companies and is also high conviction at around 70% in the top 10 holdings. Over the last year it has swung from a 30% premium to a 45% discount, mainly due to that perception of higher risk. I think some of that is very much deserved as their is a reasonable chance that increasing interest rates will cause one of those companies to go bust or at least put of its future listing plans. However some of it is simply investors trying to get out at any price.

Albermarle

Prism said:

Albermarle said:

george4064 said:

Just to add another angle on things; often a trust will swing to a discount when the trust price (and probably the market in general) is riding high and vice versa (so swing to a premium or discount will narrow) when it’s riding low.

Reason behind this theory is that when stocks are more expensive people will less willing to buy them (and more bothered about the discount/premium) so a discount may form, whereas when the market has recently tanked you’ll get many people buying at whatever discount/premium because they know they’re buying in at a lower price than it was, therefore pushing the trust’s share price up vs the NAV.

I guess the point I’m making is that it can sometimes be a bit of a false economy, if what I described above ever happens, even only slightly,

I can not say I have ever studied it in detail and am not an expert at all, but I had the impression that when the markets dives, the higher risk level IT's dive even more, for a short period anyway. In other words they overshoot the market movement and a bigger discount/smaller premium opens up for a while.
Maybe that only applied to the ones I follow though.

I would say that certainly seems true. I hold the Chrysalis IT which invests mostly in private companies and is also high conviction at around 70% in the top 10 holdings. Over the last year it has swung from a 30% premium to a 45% discount, mainly due to that perception of higher risk. I think some of that is very much deserved as their is a reasonable chance that increasing interest rates will cause one of those companies to go bust or at least put of its future listing plans. However some of it is simply investors trying to get out at any price.

That is a dramatic move ! 

adindas

Prism said:

Albermarle said:

george4064 said:

Just to add another angle on things; often a trust will swing to a discount when the trust price (and probably the market in general) is riding high and vice versa (so swing to a premium or discount will narrow) when it’s riding low.

Reason behind this theory is that when stocks are more expensive people will less willing to buy them (and more bothered about the discount/premium) so a discount may form, whereas when the market has recently tanked you’ll get many people buying at whatever discount/premium because they know they’re buying in at a lower price than it was, therefore pushing the trust’s share price up vs the NAV.

I guess the point I’m making is that it can sometimes be a bit of a false economy, if what I described above ever happens, even only slightly,

I can not say I have ever studied it in detail and am not an expert at all, but I had the impression that when the markets dives, the higher risk level IT's dive even more, for a short period anyway. In other words they overshoot the market movement and a bigger discount/smaller premium opens up for a while.
Maybe that only applied to the ones I follow though.

I would say that certainly seems true. I hold the Chrysalis IT which invests mostly in private companies and is also high conviction at around 70% in the top 10 holdings. Over the last year it has swung from a 30% premium to a 45% discount, mainly due to that perception of higher risk. I think some of that is very much deserved as their is a reasonable chance that increasing interest rates will cause one of those companies to go bust or at least put of its future listing plans. However some of it is simply investors trying to get out at any price.

It is a general truth in the technology sector especially in IT, fintech, Biotech. Another examples is that you could also look at SMT. While Nasdaq are down around 30%, S&P500 is around 20% the SMT were already down around 57% from its all time high in November.

You could also have a look in individual small to mid cap high growth stocks in technology some of them are even down 80%, a few are 90%. Most of these stocks are unprofitable. In the current bear market environment, high interest rate these companies are hated, investors are very careful as there are the risk they could dilute their shares, doing reverse split when they are hovering around $1 or go bankrupt if they could not manage their debt to stay afloat.

But these technology sector is high risk high reward play. When they recover, they also recover with multiplier. It is not uncommon they rise 20%+ in a day without catalyst. In Biotech sector for instance when there is a strong catalyst such as successful drug trial, authority approval they could shot up 10X in just a few days.