Comment: Investment trust discounts hit all–time low

Bill Jamieson. Picture: Ian Rutherford
Bill Jamieson. Picture: Ian Rutherford
Share this article
Have your say

A constant concern of anyone considering an investment in the stock market is timing – no-one wants to buy investments at the top of a market and then suffer a downward slide.

The problem is there is no infallible guide as to when stock markets are close to a peak or floor. For millions of private investors who have money in investment trusts, there is, however, one measure that should put us on alert – and today it is flashing amber.

A distinguishing feature of investment trusts is that, unlike unit trusts, shares in the trust itself are quoted on the stock exchange and can move independently of the basket of shares in the underlying portfolio. Historically, shares in investment trusts have stood at a discount to the value of the portfolio of shares they hold. If the trust specialises in a sector that has fallen out of fashion – mining or commodities at present – the discount rises. If the trust specialises in a sector that is doing well (currently smaller companies) they are more likely to stand at a premium.

But for decades investment trust shares have on average stood at a discount to their portfolio worth and this has long been one of their attractions: investors can buy in to a portfolio of shares at less than it would cost to buy and hold the shares directly.

It should never be the sole reason for buying an investment trust. But when you can buy into a trust standing at, say, an 8 to 10 per cent discount to assets, it can add to an investor’s “comfort factor”.

However, such has been the strength of stock markets – and the growing popularity of investment trusts that have outperformed their unit trust counterparts – that the average discount has fallen sharply.

Figures from the Association of Investment Companies shows the average discount has slid to 3.4 per cent, its lowest since records began in 1970. Compare this to October 1976 when inflation was raging and the economy was in deep trouble – and the average discount peaked at 41.5 per cent.

More recently, between November 2004 and August 2008, the average ­investment company discount regularly traded in the low single digits. In fact, in February 2006, the average ­discount fell to 3.5 per cent.

Then came the credit crunch. The average discount widened out to 16.6 per cent at December 2008 – the highest since the 1980s – before returning to single digits since October 2010.

The low average discount to assets works to disguise another unusual trend – the appearance of trusts standing at a premium to the value of their assets. Today around 20 per cent of trusts are standing at a premium.

The Money Morning website argues this is not just a story of generally buoyant markets, but also of the impact the retail distribution review – levelling the playing field for independent financial advisers in choosing an investment trust over a unit trust – has had in the growing awareness of the merits of investment trusts and boosting their popularity.

Today’s ultra-low level reminds us that equity markets can be capricious. Investors are apt to seize on events – arguably not that important in themselves – to take profits. Such changes of mood can be sudden and often indiscriminate. These premiums can disappear in a trice and the average discount veer sharply upwards. And today’s low average discount could be signalling that a correction lies ahead.

Today’s abnormally low discount level reminds us shares are now on historically high ratings and that investors need to proceed with caution. Spreading purchases over a period can help mitigate the risks of bad timing.