Why you shouldn’t obsess about discounts
David Prosser explains the diminishing impact of investment trust discounts over time.
Investors and financial advisers often worry about investment trust discounts. The structure of an investment trust, where you get exposure to the fund’s assets by buying its shares on the stock market, is what gives rise to this issue – sometimes, share price movements get out of sync with what’s happening in the underlying portfolio. People sometimes see this as adding unwanted complexity to the decision about whether to buy into an investment trust.
In that context, analysis just published by the investment platform Fidelity makes interesting reading. It includes some familiar points that might ease your fears about discounts – that they can provide an opportunity to buy assets cheaply, for example, and that we might be about to see discounts on many trusts narrow – but it’s the data on the potential impact on performance that really catches the eye.
While discount movements can have a significant impact on returns in the short term, that effect become less noticeable over time.
David Prosser
Fidelity worked with the Association of Investment Companies (AIC) to analyse how changes in a trust’s discount would impact the returns earned by investors. It assumed the fund’s portfolio would generate an annual return of 7% and then looked at what that would deliver in share price returns if the fund’s discount doubled from 10% to 20%, halved from 20% to 10%, or simply stayed the same.
The big takeaway from this exercise is that while discount movements can have a significant impact on returns in the short term, that effect become less noticeable over time.
After one year, for example, shares in an investment trust delivering net asset value (NAV) gains of 7% would be up 20.4% if the fund’s discount had halved, but down 4.9% if the discount had doubled.
Over 20 years, by contrast, the same fund would deliver an annualised share price return of 7.6% if its NAV rose 7% a year but its discount halved, and an only marginally lower 6.4% with the same NAV growth and a doubling in the discount. In other words, by the time you get to 20 years, the effect of even very sizeable changes to the discount, for better or worse, is relatively small.
Investment via regular savings – paying money into the fund each month or each year, rather than in one lump sum – also makes a difference. Fidelity’s analysis shows this can reduce the effect of discount changes even further.
These are important findings, given why and how most people invest. First, investment trusts are intended to be long-term holdings and there’s the potential, at least, for outsized returns over an extended period, but with the possibility of ups and downs along the way. Assuming you accept this premise, Fidelity’s numbers suggest you don’t need to be so concerned about discounts.
In addition, regular saving is a popular option with many investors – not least since many people don’t have large sums to invest and are making savings out of their income on an ongoing basis. Again, Fidelity’s analysis suggests these investors’ anxieties about discounts will often turn out to be overplayed.
None of which is to dismiss investors’ fears about this issue. There’s no denying that discounts (and sometimes premiums for that matter) do present an extra issue to get your head around if you’re thinking about putting money into an investment trust. Still, Fidelity’s numbers suggest that if you’re a long-term investor or a regular saver (or both), you can afford to take a fairly relaxed view.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
