Why are investment trust discounts so high?

Some investment trusts are trading at bigger discounts than usual, with the average discount sitting at 14%, according to the AIC. But some trusts trade at discounts of more than 50% - we reveal the trusts on a bigger than normal discount.

A total of 26 investment trusts trade on a discount that is more than five percentage points greater than their five-year average. At the most extreme end of this is life science investor Syncona, which has gone from trading at a premium to net asset value (NAV) for many years to now trading at 52.8% below NAV.

Investment trusts with exposure to private assets are among those trading on larger discounts than their five-year average. That’s a reflection of investor fears about market conditions not being conducive to selling stakes in private holdings.

Like Syncona, Lindsell Train Investment Trust also used to trade at a premium as investors were prepared to pay a high price to get exposure to the Lindsell Train asset management business. Most of the big asset managers have their shares listed on a stock market, yet Lindsell Train has remained a private business. The Lindsell Train investment trust holds a stake in it, and when Nick Train’s funds were doing well investors were happy to pay up for access. Performance hasn’t been as strong in recent years, hence why the trust now languishes at a discount.

Are discounts normal?

Discounts have become more pronounced in recent years as higher interest rates have increased the appeal of lower risk assets like bonds and cash.

The table below shows equity-focused trusts which are trading at a discount that is at least five percentage points greater their average level over the last five years.

A discount on an investment trust is best understood as the gap between the share price and the net asset value (NAV) per share. Net asset value is the value of the trust’s assets minus any liabilities, which can be divided by the number of shares in issue to get a per share number.

For example, a trust with 100p of assets per share and a 95p share price trades at a 5% discount. Discounts can give savvy investors the chance to buy assets for less than they are worth, at least in theory, but in practice it is important to do some digging and understand why a discount exists.

A wide spread of trusts trade at a discount, which may pique the interest of bargain-hunters. However, buying at a discount isn’t automatically a good thing, because the price of investment trusts depends on a raft of factors ranging from market sentiment towards the strategy to the manager’s track record, so there may be a good reason that explains a persistent discount to NAV.

What is the discount telling you?

The level of discount at which you buy can affect the return you get as a shareholder and how much discounts matter really depends on your time horizon. Short-term traders may invest at deep discounts in the hope they narrow quickly, whereas long-term investors tend to be less fixated on the gap between share price and NAV.

Discounts are usually down to a mixture of factors and there may be no simple fix or catalyst to bring the discount in. Subdued demand for a trust’s shares could be attributable to poor performance or an investment style that is firmly out of favour. Trusts with a low profile can also trade at sizeable discounts, as those managed by boutique fund management firms can fly under the radar of many investors.

Another factor is changes in supply of a trust’s shares, which can happen through share buybacks or issuing new shares. Buybacks reduce supply, which can reduce a discount or stop it widening further. Issuance has the opposite effect and is normally done when trusts trade at a premium, stopping that premium getting too wide and putting off new investors. Boards use buybacks and issuance to reduce the volatility of discounts.

Trusts investing in unlisted assets often trade at discounts to reflect the greater uncertainty involved in valuing these assets, and the fact that they are less liquid or, in other words, more difficult for managers to sell should they want to.

If you buy at a discount and the share price rises more than the NAV, narrowing the discount, you’ll get a better return than the NAV. If the discount widens, for example by the NAV rising faster than the share price, you won’t get as big a return as the NAV but you won’t necessarily make a loss. If the discount widens because the share price and the NAV are both falling, but the share price is falling faster, you will lose more than the fall in the NAV.