Shares in investment trusts are traded on the stock market. This means that their prices are determined by supply and demand.
The value of the underlying assets, the investments the fund holds, should be reflected in the trust's share price, but this does not mean it will always equal the actual value of the holdings in the trust.
If a trust is particularly popular, perhaps because investors think the shares it holds will be worth a lot more in the future, demand for the fund will drive up its price on the Stock Exchange. When this occurs and the total value of the shares is higher than the actual value of the investments held in the trust, the shares are said to be trading at a premium.
More often than not, however, the opposite occurs. Where the total value of the shares is less than the actual value of the investments held by the trust, the shares are said to be trading at a discount. So while the value of the assets in the trust may be increasing, the investment trust's share price will not necessarily also rise.
In the past couple of years, investment trust discounts have widened. This is because there are far more investment trusts than there used to be, accompanied by a fall in demand.
In 1993, investment trusts were very popular and the average discount for the sector was 3 per cent, its lowest for more than 20 years. This led to a large number of new investment trusts being launched. It wasn't long before supply outstripped demand and discounts started to widen again. A number of the new trusts invested in what became unpopular markets, such as global emerging markets, rather than investing in the US and UK markets, which have done well.
"Disappointing performances saw investment trust shares fall further out of favour. The strong performance of the pound added to the problem," says Peter Walls, investment trust analyst at Credit Lyonnais Laing. "In the past 18 months sterling has appreciated and this has hit investment trust returns, as many funds have part or all of their assets overseas."
The average investment trust discount is now just over 11 per cent. This is forcing companies to look at taking steps to reduce their discounts. The directors who sit in investment trust boardrooms have become more independent and are more likely to put pressure on the managers of a fund if it is not doing well.
In other instances, boards of some of the more recently launched trusts have approved buy-back schemes, where trusts buy their own shares in a bid to increase the price of the shares and so reduce their discount.
Others have looked to reduce discounts by merging and the number of investment trusts being taken over by other investment trusts has increased. Some have taken steps to convert to unit trust status.
Before investors become too alarmed about discounts, the Association of Investment Trusts (AITC) points out that investment trusts have been around for more than 130 years and discounts go in cycles. Ten years go the average discount was 22 per cent, three years later it was 13 per cent and by 1993 it stood at 3 per cent.
Discounts also vary enormously between and within investment trust sectors. Smaller companies have not performed well recently. This is reflected in the average discount in the smaller companies investment trust sector which is around 13 per cent. In contrast, larger UK companies have done well and the discount for trusts in the UK capital growth sector, which invests in the leading British businesses, is 8 per cent.
Some of the biggest discounts can be found in those funds specialising in emerging markets, such as Abtrust Emerging, which is on a 21 per cent discount. Despite the recent turmoil in the world stock markets, the average discount for general emerging market investment trusts is 15 per cent.
So do large discounts offer a good opportunity to buy into a trust cheaply? Some deserve their large discounts, especially when investors think the underlying assets are heading for a downturn or the fund manager is poor. "But where investors think the underlying assets will perform well, the management of the trust is good and the trust meets their investment needs, investing now can make sense," says Eleanor Burton, spokeswoman for the AITC. "Some investment trusts represent very good value at the moment because with the average discount at 11 per cent, you can buy pounds l worth of assets for 89p. You also get the income from that pounds 1 of assets."
Sarah Bates, managing director of Invesco closed funds, does not expect discounts to widen much more: "Some of the areas which look interesting are UK small caps which we think will continue to pick up. And for the brave, some of the investment trusts investing in the Asian markets still offer good long-term opportunities."
John Szymanowski, an investment trust analyst at Warburg Securities, thinks there are a number of funds which have performed well but are trading on a wider-than-average discount and offer good value. He likes the look of British Assets, on a 17 per cent discount, and Foreign & Colonial Emerging Markets, on 12 per cent.Reuse content