Discounts and premiums

An investment company’s share price is mostly driven by the value of its portfolio. However, it can also be affected by general sentiment towards the company and other factors. As a result, the share price may be higher (‘at a premium’) or lower (‘at a discount’) than the value of the underlying investments.

For example, an investment company with £100m of net assets and 100m shares would have a net asset value per share (NAV/share) of 100p. If the share price was 90p, it would be trading at a discount of 10%. If the share price was 110p, it would be trading at a premium of 10%.

Most investment companies trade at discounts most of the time. However, over the last couple of decades, the average investment company discount has generally narrowed.

Several factors can affect the discount or premium at which an investment company’s shares trade:

  • general market sentiment
  • sentiment towards the asset class in which the company invests
  • performance of the investment company
  • reputation of the fund manager
  • marketing and press coverage of the investment company
  • any discount control policies

Discounts and premiums present both opportunities and risks.

The opportunity to buy 100p of assets for 90p, for example, could enhance returns over time if the discount narrows. Income investors will also receive a higher yield on discounted assets than if they bought the assets without the discount.

However, if discounts widen during the period an investor holds shares, the return will be worse than that of the underlying portfolio.

The tendency of discounts and premiums to change over time is one factor that increases the volatility of investment company returns, and makes investment companies more suitable for long-term investors who can benefit from their ability to outperform over longer periods.