Discounts and premiums to NAV (net asset value), which is the value of all the investments an investment trust holds minus any debt or loans, are among the trust universe’s unique quirks and can confuse novice investors. At the moment the vast majority of trusts trade at a discount.

Annabel Brodie-Smith, the AIC’s (Association of Investment Companies) communications director, says: ‘Only around 20 investment trusts are currently trading at a premium as demand for trusts has been hampered by the impact of rising interest rates, unhelpful cost disclosure regulation as well as consolidation in the wealth management industry.’

Few trusts trade at consistently high premiums, but these rare situations do occur; they can reflect bumper demand from investors due to a fund’s strong performance record, its focus on an investment hotspot or perhaps faith that the manager can continue to outperform the market.

However, premiums can put investors in a bit of a quandary. Paying a share price that is higher than the value of the underlying assets means immediately giving up some future performance, since there is no discount to close. Trusts on a premium also carry de-rating risk. When a once-popular trust becomes unpopular and slides from premium to discount, investors lose money.

WHICH TRUSTS TRADE ON PREMIUMS?

Investing in the small band of trusts trading at a premium may seem counter-intuitive to the ‘buy low, sell high’ mantra, but dismissing this cohort means ruling out some first-rate funds with copper-bottomed reputations. Among these rarities is private equity trust 3i (III), a market darling whose 34.3% premium reflects strong performance and investor appetite for exposure to Action, the fast-growing Dutch value retailer which makes up the bulk of 3i’s portfolio. 3i generated a total return of £3.84 billion or 23% on shareholders’ opening funds for the year to March 2024, a performance built off the back of a 36% increase the previous year.

Shares has a positive stance on JPMorgan Global Growth & Income (JGGI), which merits its 1.2% premium as the top share price total return performer in the AIC Global Equity Income sector over one, five and 10 years, with a formidable five-year haul of 114.6%.

One of our running Great Ideas selections, JPMorgan Global Growth & Income is among the ‘most bought’ trusts on investment platforms. This popularity reflects the balance it offers between growth and income, which allows the fund to perform well in different style regimes. The trust also pays quarterly distributions that are set at the beginning of each financial year, and on aggregate the intention is to pay dividends totalling at least 4% of the fund’s NAV at the time of announcement.

This can be topped up using the trust’s capital reserves in the event of a shortfall. The unusual feature of paying out a dividend from net assets and share buybacks has helped keep the shares trade close to NAV or at a premium. Co-managers James Cook, Tim Woodhouse, and Helge Skibeli look for the best companies wherever they are listed and focus on high-quality, cash-generative businesses which can ‘control their own destiny’ and not be knocked off course by the economy or competitive forces.

A PRIVATE EQUITY PREMIUM

Besides 3i, the only other fund on a premium in an AIC Private Equity sector awash with double-digit discounts is the high-flying Literacy Capital (BOOK), whose managers focus on smaller businesses they can help grow in size and value, which drives superior returns for shareholders.

Given its strong NAV returns since listing in 2021, Literacy Capital remains a compelling investment proposition and is also doing some good in the world through its charitable mission of helping disadvantaged children in the UK learn to read, with donations equivalent to 0.9% of NAV made each year, although investors might want to wait for a discount to open up again before buying the shares.

Excitement surrounding the hot returns on offer from the globe’s fastest-growing major economy combined with a spicey performance since launch explain Ashoka India Equity’s (AIE) 2.3% NAV premium. The fund has been the best-performing India specialist trust since its 2018 inception with the market cap swelling to almost £390 million through strong asset performance and share issuance that has improved the trust’s liquidity. While Ashoka India remains an attractive vehicle for tapping into India’s positive economic picture and a stock market delivering solid earnings growth, any growth slowdown in the populous Asian nation or stock picking mistakes from the manager could see the trust’s premium evaporate.

SMALL CAP STAR TURNS

The select bunch of trusts trading at premiums also includes a trio from the UK Smaller Companies sector. This may surprise some readers given the prevailing negative sentiment towards the market’s small fry which has left most sector constituents languishing on double digit discounts. Stock market newcomer Onward Opportunities (ONWD:AIM) trades on a 5.1% premium, while two trusts with a knack for selecting takeover targets, namely  Odyssean (OIT) and Rockwood Strategic (RKW), sit on premiums of 0.6% and 2% respectively.

Onward recently (11 April) reported an 11.3% NAV total return to 106.5p for the nine months from its March 2023 IPO (initial public offering) to the end of December. That compares to a 3.7% decline for the AIM All Share Index and demonstrates that manager Laurence Hulse’s process of spotting dynamic, yet undervalued companies and actively engaging with them to realise hidden value is already paying off. Thanks to this premium Onward, which raised £12.8 million from an IPO priced at 100p per share, has been able to issue new shares and expand its capital base.

Managed by Richard Staveley, ravenous demand for value-focused fund Rockwood Strategic reflects its stellar performance. Another running Shares Great Idea, Rockwood has delivered a five-year share price total return of 177.5%. Harwood Capital’s Staveley, who has personal ‘skin in the game’, manages a highly concentrated portfolio of stocks with ‘deeply undervalued future cashflow potential’ and re-rating catalysts in place. The fund has benefited from a series of net asset value-boosting takeover approaches. Odyssean invests in a concentrated portfolio of well researched UK small caps, typically too small for inclusion in the FTSE 250. Constructive corporate engagement is a key part of managers Stuart Widdowson and Ed Wielechowski’s winning approach, with the duo able to draw on a lengthy and successful track record in public and private equity investing.

DON’T FORGET THIS DIVIDEND MACHINE

Also trading on a premium that Shares believes is well-deserved is the unique Law Debenture (LWDB), a rare combination of an investment trust and a cash-generative professional services operating business that continues to generate strong results.

Investors are paying up for a trust with a long-run record of outperforming peers and the FTSE All Share benchmark, while Law Debenture’s dividend growth of 69.3% over the last five years is the highest in the UK Equity Income Sector. In addition, the trust has either increased or maintained the dividend for 45 years.

Understanding premiums and discounts

Since investment trusts are publicly traded companies listed on the London Stock Exchange, you invest in them by buying their shares. If the share price is higher than the NAV per share, the trust trades at a premium, which means it is popular with investors and there is bumper demand for its shares. Conversely, if the share price is lower than the NAV per share, the trust is on a discount, which suggests the fund is out of favour and demand for its shares is weak.

Generally speaking, investing in trusts at a discount is an opportunity for investors to purchase the underlying assets for less than their true worth. Investing at wider discounts should lead to better returns since not only are you buying assets on the cheap, but periods when discounts have widened often coincide with lower underlying valuations. This sets the investor up for a strong recovery when market conditions improve, although large discounts can persist for long periods.

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