Getting to grips with discounts and premiums
7 May 2015
Since shares in an investment trust are traded on the stockmarket, the price is based on supply and demand among investors, rather than what the fund’s underlying investments are worth, known as the net asset value (NAV). When the share price is below the NAV, the investment trust is said to be trading at a discount. If the share price is above the NAV, this is known as trading at a premium.
Why buy at a discount?
Buying investment trusts at a discount is often seen as a good opportunity for investors, but understanding why a trust is trading at a discount is crucial when deciding whether or not to invest. After all, a ‘good price’ does not necessarily equate with good value. There is no guarantee that any discount will have narrowed – giving you an additional return relative to any movement in the NAV – by the time you come to sell.
The reasons for discounts are varied. A trust that invests in an area that is currently out-of-favour with investors will likely trade at a discount to NAV. Similarly, if a fund manager is underperforming, or investors do not believe in the fund’s longer-term prospects (perhaps due to poor shareholder communication), they might sell their shares. When supply exceeds demand in the stockmarket, then a discount is likely. If the discount seems disproportionate with the fund’s peer group or growth aspirations, however, then the risk may outweigh the potential reward.
Why buy at a premium?
The skill of a fund manager or the growth prospects of an area in which a fund invests can drive investor demand, pushing the share price to a premium over the NAV. The premium is essentially a sign of the market’s faith (sometimes called positive sentiment) in the investment trust’s prospects, which is why some investors are prepared to pay the extra.
If an investment trust is trading at a premium and this increases, you’ll gain an additional return relative to any movement in the NAV. However, if an investment trust is trading at a premium and this decreases, this will have a negative impact on your return relative to any movement in the NAV.
As with all investment decisions, it is important to be well-informed when looking to buy or sell shares in an investment trust. Fund providers’ websites and factsheets will often provide you with both the NAV and share price information, together with the discount/premium as a percentage.
If you are thinking about making a new investment or changing your investment strategy, speak to your Financial Adviser. If you do not currently have a Financial Adviser, you can find one near you at www.unbiased.co.uk
Please remember that the value of investments and the income from them may go down as well as up and you may not get back the amounts originally invested.
To find out more, please visit www.schroders.co.uk/its
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Schroders has expressed its own views and opinions in this document and these may change. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
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