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Last week we highlighted SMT trading at a huge discount to net asset value and the potential for the gap to close...

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Which led to some questions, such as....

Why does an Investment Trust trade at a premium or discount to its net asset value?

Let's start with a quick definition...

What is an Investment Trust?

An investment trust is a type of collective investment scheme that pools money from investors and invests that in a portfolio of assets, such as shares, bonds, property, or alternative investments.

Perhaps tracking specific investment themes, styles or particular market. For example “Japan smaller company growth”

Unlike open-ended funds, which can issue or redeem units depending on demand, investment trusts have a fixed number of shares in issue, that are traded on a stock exchange like any other company.

The price of an investment trust’s stock is determined by the interaction of supply and demand in the market.

What do we mean by NAV?

However, the price may not always reflect the underlying value of the assets held by the trust, which is measured by its net asset value or NAV.

The NAV is calculated by subtracting the trust's liabilities from its total assets and dividing by the number of shares in issue.

The difference between the share price and the NAV per share is expressed as a percentage and is known as the discount or premium.

A discount occurs when the share price is lower than the NAV per share, meaning that investors can buy the trust's assets for less than their face value.

A premium occurs when the share price is higher than the NAV per share, meaning that investors are paying more to own the investment trust than the face value of its assets per share.

What factors influence the level of discount or premium in the shares of an Investment Trust?

Various factors can influence the level of discount or premium of an investment trust. These include:

  • The performance and prospects of the trust's portfolio. If the trust has a strong track record of delivering returns or has exposure to sort-after sectors or regions, it may attract more demand and trade at a premium.
  • Trusts run by managers with good long-term track records, or those in market niches may trade at a premium to NAV.
  • However, if the trust has underperformed or has exposure to unattractive or risky assets, the trust may face more selling pressure and its shares may trade at a discount.

Premiums and discounts are often driven by investor sentiment & expectations.

If investors are optimistic about the prospects of the trust or its asset class, they may be willing to pay more for its shares and drive up the premium.

But if investors are pessimistic or even fearful, they may be keen to sell their shares and thus drive the price to a discount.

The liquidity in, and size of the trust can also be a factor. Smaller and less liquid trusts can (and often do) trade at wider discounts or premiums than larger and more liquid ones.

Simply because the underlying market in the trust's shares, and indeed its underlying investments, may have fewer market participants, which in turn can lead to higher volatility in the trust’s stock price.

The value of the underlying assets an investment trust owns may be discounted or haircut by the market to reflect their value in a fire sale or forced liquidation.

Can Investment Trusts influence the discount or premium that their shares trade at?

Some trusts may have mechanisms in place to reduce or limit the level of discount or premium, these include share buybacks or issuance, tender offers, conversion rights, or discount control policies.

What's more, investment trusts often take a cross-holding in another investment trust if they believe the discount to NAV is unwarranted.

Here are some recent examples of significant discounts to NAV among UK listed investment Trusts:

  • Aberdeen Emerging Markets: a discount of 15.8% to NAV as of 31 March 2023
  • Henderson Far East Income: a discount of 14.9% to NAV as of 31 March 2023
  • JPMorgan Global Growth & Income: a discount of 13.9% to NAV as of 31 March 2023
  • Temple Bar Investment Trust:  a discount of 13.8% to NAV as of 31 March 2023
  • Edinburgh Investment Trust: a discount of 13.7% to NAV as of 31 March 2023
  • Murray International Trust:  a discount of 12.9% to NAV as of 31 March 2023
  • Fidelity China Special Situations: a discount of 12.7% to NAV as of 31 March 2023
  • Scottish Mortgage Investment Trust: a discount of 11.8% to NAV as of 31 March 2023
  • Alliance Trust: a discount of 11.6% to NAV as of 31 March 2023
  • Monks Investment Trust: a discount of 11.4% to NAV as of 31 March 2023

In summary

Investment trusts can trade at a premium or discount to NAV due to various factors that affect its supply and demand of the stocks and its investments in the market. As traders we should be aware of these factors and their implications when buying or selling investment trust shares.