Investment Trust Discounts and Premiums: Insights and Recommendations

by George Hatjoullis

A great deal has been written about the ‘amazing’ discounts offered by investment trusts at the moment. Some even suggest that this typical discount offers ‘value’. Perhaps it does but this is not self evident. In order to illustrate the problem I will regurgitate the statistics for two trusts in which I am invested and have been invested for some time. Trust 1 is classified as Global. Trust 2 is classified as Asia Pacific Equity Income. Trust 1 typically trades at a discount and is presently trading at -6.5% to NAV. Trust 2 typically trades at a premium and is presently +2.6% to NAV. Trust 1 is an AIC dividend hero with 52 years of continuous dividend increases. Trust 2 is classified as a future dividend hero with 16 years of continuous dividend increases. It is not difficult to identify the two trusts from the AIC site but bear with me for the moment.

Neither trust is highly leveraged. Trust 1 has slightly lower leverage at 3% whilst Trust 2 has 6% leverage. The trailing dividend yield on Trust 1 is 1.7% and it has almost 2 years of revenue reserved to pay dividends. Trust 2 offers a trailing dividend yield of 10.3% and has a revenue reserve of circa 6 months. The annualised 10, 5, 3, and 1 year performance of Trust 1 is 12.18%, 13.56%, 12.7%, and 26.15%. The comparable figures for Trust 2 are, 4.21%, 0.33%,-1.6%, and 4.83%. The 3 year standard deviation of Trust 1 is 12.53 and for Trust 2 it is 14.75. The ongoing charge for Trust 1 0.64% and for Trust 2 it is 0.97%. Presumably, you are beginning to see where I am going with this.

Trust 1 has consistently outperformed its peer group ( as identified by Morningstar) and beaten its self selected index. Trust 2 has not outperformed its peer group and shows no benchmark in its marketing material. Both funds hold a similar number of stocks (around 60). So what is the significant communication offered by the past and present discount and premium? Trust 2 is better placed to issue more shares and increase the AUM. None of this explains the discount or premium. The 5 year dividend growth rate for Trust 1 is 4.58%. The equivalent growth rate for Trust 2 is 2.3%.

The distinguishing characteristic is the high current yield of Trust 2. Also the two trusts draw from different asset populations and are managed by unrelated managers. Trust 1 also has a distinctive shareholder register with a prominent single shareholder. It is quite difficult to fashion a convincing explanation for the discount and premium from these differences. Looking at the raw data one might reasonably speculate that Trust 2 typically trades at a discount. It does not.

My conclusion, from these and other trusts that I own, is that the discount and premium do not convey much information other than, in the case of a discount, the fund may buy its own shares, and , in the case of a premium, it may issue more shares. The most successful trust investment in my portfolio is Trust 1. I invested when it was trading at a 10% discount. The return has had very little to do with the marginally narrower discount today. The vast amount of quasi independent research /marketing material exhorting people to buy Investment Trusts because they offer ‘value’ is best ignored. Do your due diligence and make sure the trust offers what you seek. And then you shall find…