Discounts shouldn’t make investors anxious

A view from David Prosser, former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine.

Investment trusts are more complicated than open-ended funds, right? That, certainly, has been the conventional wisdom presented by independent financial advisers to their clients – largely because investment trust shares tend to trade at a discount to the value of the underlying assets.

Here’s the thing though. Even if you accept that discounts add complexity – and many would disagree – they have become less and less noteworthy in recent times. In fact, the average investment trust ended last year on a discount of just 3.4 per cent, the lowest figure since the AIC began keeping records in 1970.

On a long-term down trend

Cynics might argue that we have been here before. After all, the average trust traded on a discount of 4 per cent in 1994, only for the figure to widen to 10 per cent within two years.

This is no flash in the pan, however. Winterflood Investment Trusts points out that the long-run average discount for the investment trust sector since 1990 has been 10.1 per cent. “However, in the past 10 years, the average has been tighter at 8.4 per cent,” analysts at the firm say.

Winterflood calculates its figures in a slightly different way to the AIC, but the point to grasp is nonetheless that investment trust discounts are on an established downwards trend.

Indeed, had it not been for the 2008 credit crunch, which damaged investment trust valuations in the same way as it wreaked havoc across other financial markets, the average figure for the past 10 years would have been much lower. Average discounts were almost always single-digit between 2004 and 2008 and have been back below 10 per cent since October 2010.

There are good reasons for this. Discounts do tend to rise and fall in line with market sentiment – when investors are nervous about markets they buy fewer equities and closed-end funds often see discounts widen. However, the investment trust industry has made concerted efforts to tack discounts over the past 15 years.

The sector has been aided by changes to regulation – share buy-backs were made easier and tax efficient in the late 1990s, for example, which enabled investment trusts to mop up excess supply of their stock. But, just as importantly, growing numbers of funds have used such tactics to bear down on discounts.

In other words, the issue of discounts is slowly becoming less important – investors who were previously unnerved by the gap between the value of a fund’s assets and its share price now have much less reason to feel anxious.

Never mind the discount, look at performance

There are two more important points to make. First, it’s worth pointing out that there’s nothing sinister about discounts. They exist only because of the structure of a closed-end fund – with a set number of shares in issue, the price depends on demand and supply in the market at a given moment, which sometimes gets out of kilter with the value of the underlying assets. Over time, however, share price and net asset value move together.

Second, remember that most performance comparisons you see between investment trusts and open-ended funds, in which the closed-end sector consistently comes out on top, are based on share price performance. Whether you feel uncomfortable with discounts or not, they don’t seem to stop investment trusts outperforming.