After a long run trading on double-digit discounts, fortunes look to have turned for the UK investment trust sector.
Latest data from the closed-ended fund sector trade body, the Association of Investment Companies (AIC), reveals the average discount to net asset value (NAV) across all UK investment trusts reached single digits for the first time in nearly four years, narrowing to 9.6% on 31 May.
Comparing month-end figures, this is the first time the average discount has been less than 10% since August 2022, when it was 9.4%.
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Those wider discounts were due to higher interest rates, regulatory issues around cost disclosures and the dominance of US big tech companies – especially the Magnificent 7.
After a challenging period for investment trusts, there is now “light at the end of the tunnel”, according to Richard Stone, chief executive of the AIC.
“The sector has reshaped itself over the past four years with unprecedented levels of M&A and share buybacks, as well as mandate changes and fee cuts to give shareholders a better deal,” he said.
Stone added that while the challenges were not over, to see the average discount return to single digits was encouraging.
He said: “This reflects the continuing appeal of the investment trust structure, which can offer exposure to virtually any asset from mainstream stocks and shares to exciting private companies such as SpaceX.”
What is an investment trust discount?
Because investment trusts are closed-ended investment vehicles – listed companies whose shares trade on a stock exchange – they have certain features that set them apart from traditional open-ended collective funds. One of these features is their share price being able to trade at a premium (higher) or a discount (lower) than their total net asset value (NAV) per share.
An investment trust’s NAV is the value of the trust’s assets minus any liabilities. This is then divided by the number of shares to get the ‘per share’ number, which is then compared to the actual share price to determine if the trust (or company) is at a premium or discount.
These typically indicate whether demand for the shares is high or low at any given time.
Doug Brodie, chief executive of Chancery Lane Retirement Income Planning, gives the example of an investment trust with a market capitalisation (market cap – the combined value of all its shares) of £50 million, but the assets it holds are worth £55.5 million.
“The market cap – the share price – is at a 10% discount to the value of the assets it owns – the NAV… A discount is simply a price off the normal price: instead of paying 100p in the pound for shares, you only have to pay 90p for them.”
Why do discounts widen or narrow?
The discount on an investment trust can narrow for several reasons. These include improved performance, increased popularity of the sector it sits in, a change in manager or other corporate activity, such as a merger with another trust, or being acquired or liquidated.
In the latter case, the assets have to be sold or absorbed into another vehicle, meaning their actual value – minus costs – is likely to be realised. A rise in corporate activity has contributed to discounts narrowing.
Further, Max King, former fund manager and MoneyWeek columnist explained that discounts are wider for trusts with unquoted assets than for those with quoted assets.
Shares in private companies don’t trade daily on stock exchanges, so their value is only determined at intermittent events when they are bought or sold. When an investment trust holds these shares, it usually values them based on the most recent valuation event – which might be out of date compared to the market’s assessment of their current worth. That can contribute towards discounts or premia to NAV.
Because private equity valuations are backward-looking, they tend to hold up when markets are falling and pick up when they’re rising.
“Hence discounts widen as investors realise they are unrealistic and fall when investors realise that valuations have become conservative,” said King.
What do narrower discounts mean for investors?
According to King, discounts appear for three reasons: poor performance; distrust of the net asset value – especially for unquoted assets; or rapid sell-off of UK-listed equities, as witnessed in the past few years.
As investment trusts are UK-listed companies with their own shares often listed on the major indices, if there’s an exodus from the UK market, it will inevitably hit UK-listed trusts as well – even if their underlying companies are global.
He warned against being seduced by wide discounts, adding that investors should instead focus on underlying performance, and be sure to understand why a discount exists and why it might come down before deciding to invest.
“Investors in the UK have been bizarrely risk-averse in recent years,” King added. “That is diminishing so, in time, discounts will disappear, existing trusts will issue more equity, new trusts will be launched and investors will be euphoric – that will be the time to turn cautious.”
Why discounts matter for income investors
Narrowing discounts also suggest that investors are seeing the value of long-term holdings, for which Chancery Lane’s Brodie said investment trusts were “the perfect vehicle”.
He added that for income-seekers, discounts become even more valuable, giving the example of M&G Investments.
“If M&G shares are yielding 6.48%, you can buy a trust that holds them and if that trust is on a 10% discount, your investment yield on those shares is actually 7.2%.
“If a trust is at a discount, even without any underlying stock market growth, its share price should, over time, grow back to match the actual value of the assets.”
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