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When it is worth paying a premium for an investment trust

When it is worth paying a premium for an investment trust

by Jennifer Hill from interactive investor | 10th February 2021 10:06

Positive news on Covid-19 vaccines led to investment trusts re-rating considerably during 2020. The average discount among equity investment trusts narrowed from 4.6% to 2.5% – the tightest level on record – according to Numis Securities.

Discounts widened slightly to 5% during January but remain significantly narrower than a 10-year average of 7.8%.

Looking across asset classes, a growing number of investment trusts – 108 of the 463 UK-listed trusts on Morningstar’s database – are trading at a premium…

Most of the 39 trusts that have traded at an average premium of 5% or more over the past year have specialist or alternative mandates.

How much is too much?

Paying more for something than it is technically worth is not a great investment strategy. Equally, just because something is trading at a discount does not make it a bargain…

In broad terms, trusts trade at premiums because there is excess demand for the shares – more buyers than sellers. While this should help to continue to support the share price, many investment trusts have discount control mechanisms which sees them issue shares to limit premiums or buy them back to narrow discounts.

“Sentiment can be fickle,” says James Carthew, head of research at QuotedData. “When fashion changes and premiums fall, share price returns can look quite poor and this can trigger more selling. There’s a danger of heightened volatility.”

…Trusts that invest in less liquid areas, such as property, private equity and infrastructure, revalue their investments infrequently, and shares trading at a premium or discount can reflect optimism or pessimism about the most recent valuation.

“Many of them adopt a conservative approach to valuation, as evidenced by managers being able to consistently sell investments at a significant premium to their last valuation,” says Carthew.

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