Why don’t investment trust prices move in line with net asset value?
Have you ever bought an investment trust only for the share price to fall by a greater amount than the decline in its net asset value? There is often a good reason why the shares are reacting in that way.
The structure of investment trusts, which sees their shares traded on the stock market, means they can trade at a premium or discount to the underlying value of their investments or their NAV (net asset value). This is different to funds such as unit trusts which always trade in line with NAV.
In plain English, with investment trusts it is possible to buy 100p of assets for 90p, meaning you’ve got a 10% discount. Equally, some trusts may cost you 110p to buy 100p worth of assets, meaning you’re paying a 10% premium.
Net asset value is the value of all the investments held by a trust minus any debt it is carrying. Trusts can borrow to invest, and these borrowings are deducted from the combined worth of its holdings to calculate the NAV.
Fund managers might prefer to be judged on the net asset value performance, but most investors will look at the share price and dividends to see how much money they’ve made from their investment.
Investors need to think about all the factors that could move the share price of each underlying company in a trust’s portfolio, and they need to think what could influence the share price of the trust itself.
These are some of the key factors that can influence the price of a company in a trust’s portfolio:
– News flow – either directly or indirectly such as news from a company in the same sector
– Financial strength or weakness
– General market sentiment
– Political developments
– Economic developments
– A change in the rating that investors are willing to pay for the stock (such as price to earnings)
The aforementioned factors will play a role in whether the companies in an investment trust portfolio see their share price rise or fall. Then there are additional factors which can also move an investment trust’s own share price including:
– Market sentiment towards investment style, sector or geography
– Change in fund manager
– Marketing activities
– Assets hit a milestone (such as £200 million) which increases the trust’s appeal to a wider range of investors
MONKS INVESTORS TAKE A HIT
Baillie Gifford-managed Monks Investment Trust (MNKS) is an example of trust whose share price, at the time of writing, was not moving in tandem with its net asset value.
On 12 February 2021, its share price was £14.62, and its NAV was £14.22, meaning it traded at a 2.8% premium. By 18 June 2021, its share price had fallen to £13.20, and its NAV stood at £13.75, meaning it was trading on a 4% discount to NAV.
Someone who had bought on 12 February would therefore have seen their investment fall 9.7% by 18 June, even though Monks’ net asset value had only declined by 3.3%. They suffered because the value of the portfolio not only fell, but also the trust went from a premium to a discount – so a double hit.
Monks invests in growth stocks which were less in favour in the first half of 2021 as the market rotated in favour of value stocks. That could be one reason why the investment trust’s shares moved to trade below the value of its assets.
Another reason behind Monks’ derating might be investors banking profits in all things related to Baillie Gifford. The asset manager had enjoyed a stellar run for several years up to late 2020 and its funds and trusts became incredibly popular with investors. In a way, it could have been the victim of its own success, and at the first sign of performance tailing off, some investors have lost interest.
Sometimes the opposite can happen – factors occur which push up the value of an investment trust’s shares by a greater amount than the rise in net asset value. This can be down to a trust’s investment style coming into favour, the trust providing a way to access a hot theme or the fund manager having a run of good luck that attracts more investors.
DEALING WITH PREMIUMS
When a trust’s shares trade at a premium they may seek to control it by issuing new stock or they might even warn investors about the risks of investing at over the odds levels.
Lindsell Train (LTI) did this consistently in 2018 and 2019 when at times its premium topped 90%. A big part of the reason behind this eye-watering premium was the perceived undervaluation of its substantial holding in asset manager Lindsell Train Limited.
These warnings proved prescient as the current premium has shrunk to just 13.5% at the time of writing as the trust and its investment style has gone out of fashion.
TRYING TO CLOSE DISCOUNTS
There are two main avenues available to a trust seeking to trim the discount to its NAV. These are sometimes formalised as ‘discount control mechanisms’ which automatically kick in when the discount is anywhere between zero and 10% or sometimes higher.
This could involve a trust purchasing its own shares in the market. By reducing the number of shares in issue this increases the NAV attributable to the remaining shares.
Tender offers or redemptions, which see the trust provide shareholders with an opportunity to sell a proportion of their shares back to the company at either a fixed discount to NAV or a price close to the NAV itself, are also used.
Another measure is a continuation vote, with trusts putting their continued existence to shareholders at a meeting, with the option of the trust being wound up and its assets sold off. The proceeds would then be returned to investors.
OTHER WAYS DISCOUNTS NARROW
A change of manager is often a catalyst for a discount to NAV to narrow. For example, since Scottish Investment Trust (SCIN) announced it was considering options to replace underperforming portfolio manager Alasdair McKinnon the discount on the trust has narrowed from more than 10% to less than 9%.
Should a new manager be appointed, and assuming investors like what they see, it is possible the discount could narrow further as the market effectively reappraises the trust.
A trust can trade at a discount because of a low profile. Often all it needs is a concerted effort on the marketing front to raise its profile and see a discount narrow.
Passing certain milestones for assets under management can also trigger a rerating. For example, breaking through the £200 million AUM mark can be a key turning point in how the market views a trust.
Some wealth managers and high net worth individuals will only look at a trust once it is worth £200 million or more, as at that point it could have better liquidity – the ease at which you can buy and sell shares.
Qualifying for one of the major FTSE stock market indices is another trigger for a trust’s share price to rise out of step with its net asset value. Tracker funds would become active buyers of the stock at this stage.
None of these catalysts are guaranteed to reduce the discount though and, particularly if you are investing for the long term, getting too hung up on modest variations in the premium or discount at which a trust trades is probably a mistake.
The track record and the extent to which the investment approach fits with your risk appetite and goals is more important.
DISCLAIMER: AJ Bell is the owner and publisher of Shares magazine. The authors own shares in AJ Bell.
Where to find useful data
You can find the NAV of most investment trusts on the website of industry body the AIC (Association of Investment Companies). Information is also available on fees, historic performance and the relationship between the share price and the NAV.
If you spot an investment trust trading at a significant premium or discount to NAV it probably warrants further investigation. One thing you can do is to examine the Z-score – you can find this on the relevant investment trust information page of the AJ Bell Youinvest website under ‘Z-statistics’.
Not to be confused with the Z-score metric used to measure the risk of bankruptcy, the Z-score for trusts shows how the current discount or premium NAV compares with the one-year average.
As a rule of thumb, a Z-score of -2 or less shows a trust is trading materially below its one-year average premium or discount to NAV while a score of 2 or more demonstrates the opposite.