Disclaimer
Disclosure – Non-substantive Research
This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. With this commentary, Kepler Partners LLP does not intend to influence your investment firm's behaviour.
To those who regularly invest in investment trusts, discounts can often be part of the opportunity. But to others, discounts are an extra complication, not to mention an extra risk. The last six weeks has probably strengthened the prejudices of both sides on the topic. The recent bout of volatility has – in our opinion – more clearly exposed both the advantages and the disadvantages of investment trusts.
In our view, discounts are like a drunk friend. They are fun to have around, but at times they let you down, often when it matters most. Ultimately the investment trust sector is defined by its discounts. The NAV is what the manager delivers, which is the reason why most of our research is focussed on the NAV. Whereas the share price return reflects the NAV with an accelerant (or detractor) – represented by the change in discount over the respective holding period.
Why discounts narrow or widen is a matter of continuing debate and, in most cases, comes down to very specific factors applicable to each trust. We would argue that – with the exception of very broad patterns or trends – past movements in discounts are significantly less repeatable than past NAV performance. Fundamentally this is why we believe it is more helpful to use historic investment trust NAV returns as a prism through which to judge the performance characteristics of a trust, rather than historic share price returns. On the other hand, there are ways to incorporate discount analysis into an evaluation of the opportunity presented by an investment trust at any given point in time. We feel that understanding the historic volatility of the discount is fundamental to the task of analysing a trust’s discount, and of defining factors that will influence it in the future.
In this article we attempt to quantify the reasons for discount volatility, and point to trusts which offer significantly less discount downside from the current level.
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