Why is my investment trust on a ‘discount’?

The idea of your investment trading on a ‘discount’ is not necessarily a phrase that instils confidence. But in the world of investment trusts, it’s a regular occurrence.

In fact, the average Global Equity investment trust currently trades on a 7.1% discount, according to Winterflood. And this doesn’t mean that your investment is losing money. So what does a discount mean?

Discounts are a unique feature of investment trusts, because while trusts have a portfolio and are making investments, they are also technically their own company. This means that their value is measured in two different ways. A discount occurs when the value of the assets in a trust are higher than the price of the fund itself.

How are investment trusts valued?

• Net Asset Value (NAV): This is a measurement that all funds have, even when they aren’t trusts. Net Asset Value is the collective value of all the underlying investments in a fund and how you track how the companies your investment trust holds are performing. It goes up when the investments the trust holds do well, and it goes down when they perform poorly.
• Share Price: Because investment trusts are a company in themselves that are listed on the stock exchange, they also have a share price. This is the same measurement that you would see for a typical stock, like Apple or Meta. Share prices are determined not just by how well the investments inside the trust perform, but by how much people are willing to pay for a share in the investment trust as a company and by wider economic factors.

A discount occurs when the NAV is higher than the share price. Conversely, you can have a premium when the share price is higher than the NAV.

It might seem strange that the NAV and the price don’t always align. This can happen for many different reasons, and we’ll explore a few below.

What would make an investment trade at a discount?

Perhaps the most straight-forward reason an investment trust would have a widening discount (meaning the gap between the NAV and the share price is increasing) is because investors are unsure about the trust.

This can happen if the trust itself has gone through a difficult period, or if the specific market it invests in has struggled. Sometimes, when a market struggles, even if the specific trust is performing well, a discount can occur.

Let’s take the example of the UK with the Fidelity Special Values trust. The trust is measured against the FTSE All-Share Index, which has had a relatively difficult period in recent years, and investors are generally pessimistic on the UK market at the moment. In total, the FTSE All Share index has returned 100% in the past five years. But the Fidelity Special Values trust has weathered the UK storm well: it has seen its NAV rise by 166% in the past five years.

Source: Association of Investment Companies

Despite the trust’s strong performance, it continues to trade at a discount. While it’s hard to pin down the exact reason investors may be hesitant around the trust, in this case part of the reason could be an unwillingness to invest more in the UK, which then reduces the share price of the trust.

How does liquidity impact discounts?

Liquidity, the level of ease there is in buying or selling a stock, can also play into an investment trust’s discount because it technically trades as a share.

The issue that investment trusts face here are that some of them are relatively small. This means they won’t have a large number of shares to trade. While this could be okay for someone looking for a long-term investment, others might shy away because they are uncertain how long it would take them to sell their share.

This can work to the advantage or disadvantage of a trust. While it may be more difficult to woo new investors, it also might mean that current investors are more likely to ride out bumps because their shares aren’t as easy to sell as some other investments. And if investors aren’t frequently selling, that means the share price can stay steady even if the NAV takes a dip.

What about the impact of private markets?

Investment trusts have the ability to invest in private companies, that are not listed on a stock exchange - which is not so easily done by other funds. But private companies bring their own complications because of how they are valued. While public companies have to offer quarterly updates to the public, private companies don’t have this obligation. This can make the economic success of a company tricky to track, and therefore makes the success of a trust investing in that company harder to track.

Many investment trusts have received criticism for this because investors are concerned that the net asset values being reported by these trusts are not as transparent.

This has been the case with RIT Capital, which holds a large portion of its investments in both private companies and other private equity funds. The trust currently trades on a 28% discount, as some investors have struggled to gain confidence in the trust without having a clear picture of the value of the investments inside it. The fund has now worked to improve its disclosure and present investors with a clearer idea of what is in the fund.

How do share buybacks affect a trust’s discount?

Although the share price of an investment trust is controlled by people buying and selling it, boards of investment trusts will often provide a cushion by initiating a share buyback. This is exactly as it seems: a company repurchases its own shares, often at a slightly higher price, to keep the share price of the company attractive.

Although this may seem like a strange practice, it’s extremely common in the investment trust industry. In fact, in 2024, there was a record £7.5bn share buybacks throughout the industry, according to the Association of Investment Companies. For example, the Scottish Mortgage investment trust last year bought back over £1bn of its shares, totalling about 8.3% of shareholder capital.

While this isn’t necessarily negative, it’s a helpful piece of information to have. Some trusts enact share buybacks as a last measure to help buoy the trust when investors lose faith, and some enact regular share buybacks to help regulate the price as a proactive measure.

Like most investments, understanding the context behind the numbers can be as important as the numbers themselves.