Discounts: a price worth paying with investment trusts?

It’s an old debate but one that recent data casts new light on. Earlier this month, the Association of Investment Companies (AIC) published a 53-year [insert link here: history of investment trust discounts. The big takeaway is that double-digit discounts – like today’s average discount of around 12% (excluding the giant 3i Group) – are very much the norm rather the exception. The 2010s were the only decade in the study where discounts consistently traded below 10% on average across the sector.

The first point to make about this data is that today’s average discount is not wide by historical standards. There has been plenty of grumbling over the past couple of years about discounts – which widened as global markets began to fret about uncertainty and volatility – but long-term investors in the sector should not have felt unnerved.

More fundamentally, however, it’s worth just getting to grips with what causes discounts in the first place. Remember, investment trusts issue shares on the stock market that provide exposure to the underlying portfolio of assets they own; that’s a different set-up to other types of collective fund, where investors get their exposure through units that can only be traded with the manager.

The price of an investment trust’s shares is determined by demand and supply in the market on any given day – and sometimes that gets out of sync with what’s happening in the portfolio. Then you get a discount (or, on occasion, a premium).

Now, why might investors want to hold shares, rather than investing through another type of investment vehicle? Actually, there are lots of reasons. You can buy or sell those shares whenever you like on the stock market, even when the underlying assets are highly illiquid, such as private companies or assets such as green energy projects. You get the protection of the stock market listing rules and company law, which require directors of public companies to run the trust in the interests of its shareholders. You get ownership rights, including the right to elect the investment trust’s board and a say in any fundamental changes to how the fund is run.

The list of positives goes on. Listed companies such as investment trusts can take on gearing, borrowing additional money to invest. This boosts returns when asset prices are rising, which is the biggest single reason why investment trusts have tended to outperform other funds over longer periods. A stock market listing provides a real time and transparent view of the value of your investment.

Is the discount issue really concerning enough to outweigh all these plus points? For many longstanding holders of investment trusts, the answer is no. They also strive to look through short-term fluctuations in discounts, keeping an eye on the prize of potential long-term outperformance.

None of which is to suggest investment trusts should do nothing to keep discounts in check. Boards and fund managers know shareholders get uncomfortable when discounts start to widen and they need to manage the trust accordingly.

Happily, at most investment trusts, interventions on discounts have become far more frequent in recent years. Share buybacks hit a record £10 billion last year. Many trusts now operate with discount control mechanisms, which automatically kick in when the discount hits a pre-agreed level. Discounts can’t be eradicated, but trusts can and do take steps to manage them.

The truth is that you can’t have your cake and eat it. If you want the benefits that the investment trust structure provides, you’re going to have to put up with the potential for discounts and premiums to develop. But with trusts now doing their best to manage that issue – one factor in today’s relatively modest average discount across all investment trusts – many investors will decide it’s worth it.