Following a difficult period for the industry, the average trust discount has returned to single digits, indicating some "light at the end of the tunnel"
Fortunes appear to have turned for the UK investment trust industry after a protracted period of trading on double-digit discounts.
According to recent data from the Association of Investment Companies (AIC), a trade association for closed-ended funds, the average discount to net asset value (NAV) for all UK investment trusts narrowed to 9.6 percent on May 31, marking the first time in almost four years that it was in the single digits.
When comparing month-end numbers, the average discount is now less than 10% for the first time since August 2022, when it was 9.4%.
Higher interest rates, legal concerns about cost disclosures, and the dominance of US large tech firms, particularly the Magnificent 7, were the causes of those larger discounts.
Watch the entire video here: AIC CEO Richard Stone says there is "light at the end of the tunnel" for investment trusts after a difficult time.
He stated, "Over the past four years, the sector has reshaped itself with unprecedented levels of M&A and share buybacks, as well as mandate changes and fee cuts to give shareholders a better deal."
Even though there were still difficulties, Stone said it was encouraging to see the average discount return to single digits.
"This reflects the ongoing appeal of the investment trust structure, which can offer exposure to virtually any asset, from exciting private companies like SpaceX to mainstream stocks and shares," he stated."
A discount for an investment trust: what is it?
Investment trusts differ from conventional open-ended collective funds in a few ways because they are closed-ended investment vehicles for listed companies whose shares are traded on a stock exchange. One of these characteristics is that the price of their shares can fluctuate between a premium and a discount to their total net asset value (NAV) per share.
The net asset value (NAV) of an investment trust is equal to its assets less any liabilities. The per share number, which is obtained by dividing this by the number of shares, is then compared to the actual share price to ascertain whether the trust (or business) is at a premium or discount.
These usually show the level of share demand at any given time.
The CEO of Chancery Lane Retirement Income Planning, Doug Brodie, provides an example of an investment trust whose assets are worth 55.5 million but its market capitalization (market cap, or the total value of all its shares) is 50 million.
"The market cap, or share price, is at a 10% discount to the value of the assets it owns. The NAV A discount is just a price reduction from the standard price; for example, you only have to pay 90p for shares instead of 100p."
Why do discounts get bigger or smaller?
There are a number of reasons why the discount on an investment trust may decrease. These include better performance, a rise in the popularity of the industry it operates in, a manager change, or other corporate actions like merging with another trust or being bought out or liquidated.
In the latter scenario, the assets must be sold or incorporated into another vehicle, which means that their true value less expenses will probably be realized. The narrowing of discounts has been attributed to an increase in corporate activity.
Additionally, former fund manager and BFIA columnist Kaylie Pferten clarified that trusts with unquoted assets receive larger discounts than those with quoted assets.
Private company shares don't trade on stock exchanges every day, so their value is only ascertained when they are purchased or sold on rare occasions. These shares are typically valued by an investment trust using the most recent valuation event, which may be outdated in comparison to the market's assessment of their current value. This may result in premia or discounts to NAV.
Due to their backward-looking nature, private equity valuations typically remain stable during declining markets and increase during rising ones.
According to King, "discounts widen as investors realize they are unrealistic and fall when investors realize that valuations have become conservative."
What does it mean for investors to have smaller discounts?
Three factors, according to King, can lead to discounts: subpar performance; mistrust of the net asset value, particularly for unquoted assets; or a quick sell-off of UK-listed stocks, as has happened in recent years.
An exodus from the UK market will unavoidably affect UK-listed trusts as well, even if their underlying companies are international, since investment trusts are UK-listed companies with their own shares frequently listed on the major indices.
Investors should instead concentrate on underlying performance and make sure they understand why a discount exists and why it might decrease before making an investment, he cautioned against being seduced by large discounts.
King continued, "Investors in the UK have been oddly risk-averse in recent years." "Discounts will eventually vanish, current trusts will issue more equity, new trusts will be introduced, and investors will be ecstatic. At that point, it will be time to become cautious."
Discounts are important to income investors.
Investment trusts, according to Chancery Lanes Brodie, are "the perfect vehicle" for long-term holdings, and narrowing discounts also indicate that investors are realizing their worth.
Using M&G Investments as an example, he continued, "Discounts become even more valuable for income-seekers."
"You can purchase a trust that holds M&G shares if their yield is 6.48 percent. If that trust is discounted by 10 percent, your investment yield on those shares is actually 7.2 percent.
"A trust's share price should eventually increase to reflect the true value of the assets if it is at a discount, even in the absence of any underlying stock market growth."
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