The past few years have been challenging for investors. An elevated stock market and interest rate volatility caused by both inflation and hawkish central banks sent many investors rushing to the sidelines. This dynamic led to indiscriminate selling and, at times, pushed investment trust prices lower, driving discounts to historically wide levels.
In fact, after the Bank of England started raising interest rates at the tail-end of 2021, a great deal of investment trusts have gone on to trade at their widest discounts since 2008’s Global Financial Crisis. In fact, the average investment trust discount fell to 16.9% at the end of October 2023 before recovering to 9% by the end of the year*
What are discounts?
An investment trust can trade at a share price that is higher or lower than its net asset value (NAV). When a trust's share price is higher than its NAV, it is trading at a premium. When the share price is lower than its NAV, it is trading at a discount. A discount or a premium is simply a number representing the relationship between a trust’s share price and its NAV (Figure 1).
Figure 1. Premiums vs. discounts
Source: abrdn, February 2024. For illustrative purposes only.
Investment trusts often trade at discounts, but over the course of a market cycle it has historically been the case that the discounts narrow and widen, like how the stock market rises and falls.
During volatile markets, discounts can widen significantly, offering investors the opportunity to purchase shares well below their NAV. Some investors prefer purchasing investment trusts at a wide discount because doing so increases a trust's distribution rate and may present a higher potential for capital appreciation if the discount narrows due to the share price rising to NAV. Because, as many investors fail to realise, discounts can also narrow as NAV falls to the price. Again, a discount or premium is simply a relationship between two numbers – nothing more.
Other investors are less focused on discounts and prefer to invest in a trust due to the trust’s investment objective and its ability to provide regular distribution payments.
“Oh, it’s a 10% discount, that looks good.” Well, unbeknownst to investors, the trust may usually be trading at a 15% discount, and this 10% discount isn’t much of a bargain. Furthermore, an investment trust discount could be driven by many different factors: poor historical performance, low distribution levels relative to peers, or market expectations of poor performance to come.
We believe it’s important to gain an understanding of what is behind the discount. If no reason can be found, or if the only reason is that the trust’s underlying asset class seems to be out of favour, those may be signs the trust’s discount is truly attractive.
Distributions, distributions, distributions
Every investment trust has a formal investment objective which details how they invest. The objective will also indicate if the trust aims to deliver capital growth, income or a mix of both. For those trusts with an income remit, investors have long valued the dividend payments and diversification benefits on offer. Step up the Association of Investment Companies (AIC) which publishes an annual ‘dividend heroes’ list of those trusts that have consistently increased their annual dividends for at least 20 years in a row.
For those trusts with an income focus, it is distributions – not discounts – that have historically been the primary contributor to total returns over longer periods of time. The benefit from a narrowing discount diminishes over time as a contributor to overall total return while distributions remain the dominant contributor.
Consider a trust that distributes 7% of NAV per year and has a 10% discount. If the trust is held for three years, assuming its NAV does not change, and its price rises to the NAV at the end of the three-year period the distribution would account for roughly two-thirds of the price return every year (Table 1).
Table 1. Most of return should come through distribution
| Year 1 | Year 2 | Year 3 | |
| Starting NAV | $10.00 | $10.00 | $10.00 |
| Starting price | $9.00 | $9.33 | $9.66 |
| Yield | 7% NAV | ||
| Ending Price | $9.33 | $9.66 | $10.00 |
| Ending NAV | $10.00 | $10.00 | $10.00 |
| Price return | $0.70 | $0.70 | $0.70 |
| Total price return | $1.03 | $1.03 | $1.04 |
| Total price return % | 11.4% | 11.0% | 10.8% |
| % from distribution | 68.0% | 68.0% | 67.0% |
| % from discount | 32.0% | 32.0% | 33.0% |
Source: abrdn, February 2024. For illustrative purposes only.
Therefore, investors may be better served by focusing on a trust’s distribution than its discount. Final thoughts While it’s exciting to follow an investment trust’s discount, it’s ultimately not value-additive. Once invested, the most important thing to assess is the trust’s total return performance and whether it is meeting investment objectives. Historically, the key, long-term driver of a trust’s performance has not been its discount, but its distribution rate. *https://www.theaic.co.uk/aic/news/press-releases/investment-company-2023-review-updated
Important information
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund's investment return and principal value will fluctuate so that an investor's shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund's portfolio.
Other important information:
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. Authorised and regulated by the Financial Conduct Authority in the UK.
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