The investment trust net asset value (NAV) offers an accurate guide to the actual underlying value of the company, but in reality, it is quite rare that the price and NAV are the same.
Generally - but not always - an investment trust will trade at a price which is below the net asset value. This is called a discount. As one might imagine, when the price trades above NAV, it is known as a premium.
To calculate NAV, it is necessary to add together the total value of all an investment trust's assets. Any debts or liabilities will then be deducted from this figure and the result will be divided by the number of shares in issue.
- The assets of a trust are calculated at mid-market prices
- Any unlisted holdings are valued by the directors
- Cash and other assets are also added
- Then the value of any loans, preference shares and debenture stock is removed
= The number which results is known as shareholders' funds
As mentioned earlier, the short term share price movement can be heavily influenced by the discount or premium, but over the longer term, the performance of the underlying investments will move prices. All investment trusts are quoted on the London Stock Exchange.
The discount or premium is expressed as a percentage rather than in pounds or pence. By using a percentage, it is easier to compare one trust with another. To give an example, if the NAV is 100 pence but the share price is 95 pence, then the discount is 5 percent.
It is easy to imagine how the nature of supply, demand, discounts, premiums and borrowed money can make the price of an investment trust more volatile than many other collective investments.
More astute readers might now be realising that it is possible to track the performance either by using share price or investment trust net asset value. Clearly, following the performance of the NAV will offer a better gauge as to the skill of the manager.
Closing the gap
Very wide discounts often offer buying opportunities to professional investors. As the 'pros' move in to pick up bargains, this can result in the discount narrowing (supply and demand at work) and virtually instant profits.
However, more likely is that the actual
investment trust manager will use the opportunity to 'buy back' some
shares and thus improve the returns for all current shareholders.
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The issue of a discount premium results in a wide number of potential power games that are played by the 'heavy hitters' of international finance. In our example above, it was suggested that a discount between net asset value and share price might be 5%. That is quite possible. Things look a little different though if the discount is 10, 15 or 20%.
Discounts to NAV of between 10% and 15% are surprisingly common in the investment trust world. This means that for fund managers with too large a discount there is always the possibility of another well funded individual, fund or company buying up lots of stock and pushing for a change of manager or to break up the trust.
Such hostile takeovers aim to narrow the gap - and hopefully turn it into a premium - so that owners can realise a profit. After all, if a 15% discount can be turned into the actual net asset value (minus repayment of the borrowed money), there might be an 8 to 12% profit to be had. Since most investment trusts are in the order of a few hundred million pounds, that is a lot of money to be fought over! And fight the financiers will...
As odd as it may sound (but probably not that odd actually), such battles can lead to Machiavellian mind games, overt power-plays, shareholder votes and legal action in a bid to make a huge and instant profit.
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