Understanding premiums and discounts
The relationship between an investment trust’s share price and its net asset value (NAV) is the most important concept to grasp, as it creates opportunities and risks that don’t exist with open-ended funds.
Net asset value per share represents the total value of all investments held by the trust, minus any debts, divided by the number of shares in issue. If you could liquidate the trust today, selling every holding at current market prices and paying off all liabilities, each shareholder would theoretically receive this amount.
However, the market price of shares rarely matches this figure exactly.
When shares trade above net asset value, they’re said to trade at a premium. Investors are paying more than the underlying holdings are worth, typically because they expect strong future performance, value the manager’s expertise or want exposure to a scarce asset class. Premiums often emerge for trusts focused on hard to access markets (such as emerging or private markets) or those with stellar long-term track records.
Conversely, discounts occur when shares trade below net asset value. This might reflect poor recent performance, concerns about the trust’s strategy, changes in investor sentiment toward the asset class or simply a lack of market awareness. Discounts can widen and narrow based on market conditions, creating volatility beyond that of the underlying portfolio.
Buying a quality trust at a wide discount can provide downside protection and improved return potential, while purchasing at a premium requires confidence that future performance will justify paying above asset value. It’s worth noting though that a wide discount may well be justified and could deepen.