Investment Trusts: Premiums and Discounts

VIDEO: Annabel Brodie Smith, communications director at the AIC, explains what premiums and discounts are and how they affect investment trusts

Holly Black 20 August, 2019 | 11:43AM



Holly Black: Welcome to the Morningstar series, "Ask the Expert." I'm Holly Black. With me today is Annabel Brodie-Smith. She is Communications Director at the Association of Investment Companies. Hello.

Annabel Brodie-Smith: Hello, Holly.

Black: We're talking all things investment trusts today. And what we're going to look into more in-depth is premiums and discounts which is something that's unique to trusts. What does that mean?

Brodie-Smith: Let me explain. When you buy an investment trust, it's listed on the stock exchange. So, you buy at the share price and you sell at the share price. So, if the share price goes up, you've made money. Now, in addition to the share price, you can value the underlying assets of the investment trust. Value of the assets divided by the number of shares and that's called the net asset value per share. So, it really gives you a figure of what the underlying assets are worth.

The difference between the share price and the net asset value explains whether a trust is trading at a discount or a premium. Now, if a trust is trading at perhaps 90p share price but its net asset value is 100p, you would say, it's trading at a 10% discount is expressed as a percentage. 

Black: So, why would something move to a premium?

Brodie-Smith: Well, it really is a factor of supply and demand. So, say, you've got a company that you've got a really good manager with very good performance or it's offering something that's very much in demand. So, for example, our income investment companies or investment trusts with obviously interest rates very low at the moment, they are particularly in demand, then you may well get a company moving to a premium.

Black: And why would something fall to a discount?

Brodie-Smith: Well, again, perhaps the performance is not so good, perhaps the fund manager leaves who's got a particularly good track record. Perhaps the sector goes out of favor. So, for example, I don't know if you remember the tech boom and bust. The tech investment trusts were all on premiums. And then, of course, the bust took place and they were all on wide discounts. So, it does sort of depend on investment fashion and what's in favor, too.

Black: So, the risk of buying at a discount is, you could think, well, I think that will come back into favor or that will do better, in which case, you can make a return as that returns back to its net asset value share price. But if it doesn't, you could lose?

Brodie-Smith: Yeah. The real problem – for long-term investors, I wouldn't worry too much about discount volatility. But you do need to be aware of it. Now, if you buy at a discount, there's a chance that that company's discount will narrow, and it will trade more closer to net asset value. But discount volatility really as an investor is more of an issue. So, if you buy at 10% discount, sell at a 10% discount, it hasn't really had an impact. I think if you buy at a significant premium, then there is a danger that that investment trust could go to a discount which would be an additional drag on your performance.

Black: I can't think of many times I would go into a shock, for example, and pay more than what's on the ticket. So, is it ever worth buying anything at a premium?

Brodie-Smith: Well, every investor has to do their research clearly. And you have to look at the analysis, has that manager got a really, really good track record, has that company got a very good track record when it comes to paying dividends. You really have to dig deep, and think is it worth paying over the odds for this company. You need to look at the sector average, the discount or a premium for the sector, and think is it out of sync, is this one particularly worth paying more for than the other companies. I would urge caution if an investment trust was on a significant premium to invest in it. But of course, it comes down to your research.

Black: And very quickly finally, how do I check?

Brodie-Smith: Well, you can go to AIC website obviously where we have all this data for each of our member investment trusts. I'm sure you go to Morningstar's website as well and you would find all of this data available on a daily basis, updated daily.

Black: Thanks very much for your time.

Brodie-Smith: Thank you.

Black: And thanks for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Black  is Senior Editor,

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