Investment company discount narrows in 2015

Investment company discounts narrowed again during 2015. That’s the headline finding of new research published by QuotedData – but the underlying statistics make interesting reading.

For financial advisers, the fact that investment company shares trade at a discount – or sometimes a premium – to the value of the fund’s underlying assets has in the past been regarded as a reason to think twice about the sector. At the very least, discounts can add complexity to the investment choice – get asset allocation and fund manager selection right and you may still not reap the full benefit if the fund’s discount moves against you.

For that reason, the general narrowing of investment company discounts is good news – QuotedData says the median discount for all investment companies narrowed last year from 7.5 per cent to 6.6 per cent. The closed-ended structure of an investment company – the price of a fixed pool of shares is determined by demand and supply in the market, which may not always accurately reflect movements in the underlying value of the assets – means all funds will sometimes trade at a discount, but the less significant it is, the less advisers will worry about it.

However, the figure for the investment company industry as a whole masks some very significant differences between sectors. At one extreme, the European Property sector saw discounts narrow by an average of 13.4 percentage points according to QuotedData. At the other, the discount on the average natural resources fund widened by 12.2 percentage points.

The largest sectors generally saw discounts narrowing. This was true of Global funds (where discounts narrowed by 2.9 percentage points), the UK (2.9 percentage points), Europe (2.7 percentage points) and UK Smaller Companies (8.1 percentage points). It was the more specialist sectors, including debt, infrastructure, biotech, leasing and natural resources where the opposite effect was more often observed.

These figures underline the extent to which a broad range of factors influence investment company discounts. All other things being equal, a deterioration in investor sentiment in a particular sector or market is likely to prompt a widening in discounts. The opposite is true where sentiment improves.

This is to be expected. It’s basically another way of saying that demand for shares in an investment company is likely to be higher where that fund offers exposure towards a sector that investors expect to perform better.

This is not to suggest, however, that investment company boards cannot influence the direction of travel – indeed, the increasingly interventionist policies of many boards over the past decade has been an important contributory factor to the steady decline in average discounts.

Many funds now have discount control mechanisms and policies in place (though some are more formal than others). These require the fund to intervene when discounts hit a certain level – for example, by buying back shares in order to bring the discount back down.

Such mechanisms provide important protection to investors worried their investment company holdings could, during difficult market periods, be hit by a double whammy of falling asset prices and widening discounts. Investment company boards may not be able to hold back the tide, but they can mitigate the effects on investors.

For advisers who worry about investment company discounts, QuotedData’s figures provide further reassurance. While discounts (and premiums) remain a fact of life, the increasingly active management of this issue by investment company boards has seen it become less burdensome – notwithstanding the usual ebbs and flows that are driven by market sentiment.