Buy low, sell high. Those four simple words can hold the key to investing success, so why on earth would anyone pay 65 per cent more for an investment than it is worth?
It is possible for investment trusts to be priced at a premium or a discount to the sum of their parts. Yet while often this is a relatively small amount, sometimes the gap can be huge.
Want to buy shares in British & American investment trust? Those will cost 65 per cent more than the value of the assets they entitle you to. Meanwhile, the Lindsell Train trust trades at a 35 per cent premium.
So what’s going on here? Why are some trusts trading at such big mark-ups and should you ever buy at a premium? We take a look.
Buying a trust that costs more than its net asset value may seem illogical but there could be good reason behind its
Investment trusts come with two valuations: their share price and their net asset value.
The former is what it costs to buy a share in the investment vehicle, while the latter represents what the value of the assets owned by that underlying share is.
It may sound counter-intuitive but many investors buy investment trusts when they cost more than the sum of their underlying holdings.
This could happen because they suspect that the net asset value (NAV) of the underlying investments are undervalued, while some are happy to pay bumper amounts for in-demand investments that can only be accessed through the trust.
Investors might also think a fund manager’s skill is so good that its premium price tag is justifiable.
There may also be another less obvious reason as to why a trust could potentially hold hidden value that if it was unlocked would make those shares worth much more.
Whatever the reason, it better be a good one to pay over the odds because you could lose a lot of money without the value of those assets falling if the share price moves in the opposite direction.
When choosing an investment trust, investors should look at what the premium is compared to the trust’s own history as well as the history of its sector.
Buying at a significant premium amps up the risk of losing money should the trust fall out of favour.
With this is mind, we take a look at the five trusts trading at the biggest premiums and explore why they are highly valued by investors. The data is accurate to 30 April 2018.
What is an investment trust?
Investment trusts differ from open-ended funds in a few ways. They are structured like a company, with shares that trade on the stock market and invest in a basket of shares, bonds or property.
They are known as closed-ended as the number of shares in the trust is limited – these are bought and sold on the stock market and supply and demand can mean they are priced higher or lower than the assets the owner is entitled to.
Investment trusts can be riskier than what are typically known as investment funds the term for unit trusts or OEICs – because their shares can trade at a premium or discount to the value of the assets they hold, known as the net asset value.
Unlike funds, investment trusts are also allowed to raise debt in order to fund investment. This means when markets perform well their investment returns can outperform the market. It also exposes investors to risk however, as debt-funded investment can result in bigger losses if markets fall.
Fidelity’s Alex Denny gives a full explanation of investment trusts in the video below.
British & American
Premium: 64.65 per cent
Ongoing charges: 4.18 per cent
5 year performance: 56.75 per cent
The trust is peculiar in the sense that it invests predominantly in investment trusts as well as other leading UK-quoted companies to achieve a balance of income and growth.
It is also incredibly small, with its outstanding shares valued at £19million.
Detailed analysts’ notes on this fund are hard to come by, but a closer look at the trust’s holdings offers some pointers on its high valuation.
Almost half of the portfolio is invested in biotechnology sector – an industry that focuses on clinical research and drug development aimed at treating diseases and medical conditions.
This space is one of the most interesting and exciting areas of the stock market because investing in a company that develops the cure for common conditions could present huge growth opportunities.
On the hand, there is also a very real possibility of providing financial backing to a company that burns through cash with very little to show for it.
Ryan Hughes, head of fund selection at investment platform AJ Bell said: ‘The trust has traded at a very large premium and it looks as if the trust is very tightly held, meaning there is very little liquidity in the market, which drives up the price.
‘The trust offers a very high yield of over 11 per cent and it is clear that some investors are prepared to pay a significant premium to access an interesting underlying portfolio and a very high yield.’
It seems that investors here are paying up for shares in very limited supply, with the option of a major upside if firm’s big ideas are right, and getting paid a handsome dividend while they wait.
Ongoing charges: 0.85 per cent
5 year performance: 245 per cent
Lindsell Train adopts a flexible investment policy allowing the trust to hold shares from across the globe, bonds, cash and other financial instruments – but the vast majority (over 71 per cent) of it is invested in UK stocks.
The reason behind the trust’s valuation goes beyond the popularity of its manager Nick Train.
Why deviations from NAV happens
Investment trusts are known as closed-ended funds as the number of shares or units trading in the trust is limited and finite.
The basic economic demand/supply relationship comes into play here – creating potential deviations from the underlying value of the fund.
As demand grow, so does the funds share price. It officially trades at a premium when the share price exceeds the trusts NAV.
A better guess is that investors believe the trust’s long-term investment in its parent Lindsell Train Limited is conservatively valued.
Some 41.50 per cent of the trust is invested in the private asset management company, so the trust stands to gain a significant amount if it emerges as significantly undervalued, perhaps if the firm was subject to a big money takeover bid – which isn’t inconceivable.
Another reason is unlike many investment trusts, the Lindsell Train trust does not attempt to manage the premium by issuing more shares.
Doing so would dilute the value of shares for existing shareholders.
Train, has openly voice his concerns on the trust’s premium level in the past.
In a recent interview with the Association of Investment Companies on the trust’s popularity, he said: ‘In terms of the outlook for the trust, the quantum and the consistency of returns, while of course welcome, bring enhanced expectations – reflected most obviously in the trust’s share price, that continues to trade at a relatively high premium to the NAV.
‘Shareholders have been warned that this level of premium is unlikely to be sustainable and is particularly vulnerable to the performance of Lindsell Train Limited which, like any fund management company, is exposed to the vagaries of markets.’
Julian Cazalet, the trust’s chairman, echos this view in the trust’s last published annual report.
‘This has traded at a heady premium to the NAV, ranging from 25 per cent to 76 per cent throughout the year,’ he said.
‘As regular readers of past Chairman’s statements will know, the directors have a concern that this level of premium is probably unjustified and is therefore unlikely to be sustainable.
‘On that basis, I repeat again my warnings to any new shareholders who buy shares on elevated premium to NAV.’
Ongoing charges: 1.45 per cent
5 year performance: 115 per cent
Syncona is an FTSE 250 hybrid investment trust that invests in a host of investment funds across different asset classes as well as companies specialising in life sciences. Investment to both is split almost 50:50.
Looking under the bonnet of the trust offers clues as to why the trust is valued so highly by investors.
The half of the business focused on life sciences appears to be the contributing factor behind the scale of the trust’s premium. This is because the healthcare sector as a whole is widely predicted to soar in the coming years, meaning there is a real opportunity for growth here.
The healthcare sectors one of the most interesting and exciting areas of the stock market and hold the potential of substantial investment growth
Trouble is, most investors aren’t able to invest in many pioneering companies in this field because their shares aren’t publicly listed. The only way around this is to invest in an investment product, like Syncona, which already has a stake.
For example, the trust has a £88.6million holding in a small British biopharmaceutical company called Autolus.
The firm specialises in the exciting development and commercialisation of products aimed at curing cancer.
Earlier in May, the company filed to go public and float its shares on the Nasdaq stock exchange.
If all goes to plan, Syncona could make some serious returns on investment by cashing in on some or all of its 38.4 per cent stake in the company.
This drives up demand for the trust in the short term which, in turn, leads to an uptick in the trust’s price tag as investors are happy to pay more for a slice of a trust tipped for substantial growth in the not too distant future.
Put simply, investors are taking a gamble – but one based on credible empirical data.
Primary Health Properties Trust
Ongoing charges: 1.99 per cent
5 year performance: 91 per cent
The trust seeks to provide quarterly income payments to investors by investing in healthcare real estate in the UK and Ireland and renting it out on long term leases backed by the government.
Here, while past performance is not necessary an indicator of future outcomes, it appears to be a key factor behind its valuation. The trust boasts a 4.66 per cent dividend yield and has managed to up its dividend payouts for 21 consecutive years.
But what the future might hold for the trust’s underlying investments is the real draw here.
The need for more healthcare facilities is acute as the UK population and the percentage of older people with greater medical needs continues to rise.
With a portfolio of 306 healthcare centres and one under development, the trust is in a good position to profit from this trend.
The trust is also set to expand its operations in Ireland where the rental income is higher.
Hughes said: ‘The trust trades at a more modest premium but does so because of the specialist nature of the underlying assets and scarcity of them.
‘The trust owns over 300 healthcare facilities and given this focus benefits from very high occupancy and high levels of certainty over its income stream which creates a very attractive investment opportunity specially with interest rates so low.
‘By having such a portfolio, it is difficult for competitors to replicate and therefore the shares of the trust are in high demand, hence the large premium.’
Independent Investment Trust
Ongoing charges: 0.25 per cent
5 year performance: 222 per cent
The trust aims to generate good returns over the long term through investment in UK and overseas shares. Its portfolio consists predominantly of UK companies with a broad spread of blue chips and smaller listed companies.
Sometimes, there is no good reason for a trust to be trading at high premiums and is therefore likely to hurt investors once the bubble bursts.
To manage to this risk, the board or some investment trust take the decision to issue new shares at a discount to NAV, which effectively dilutes the value of shares for existing shareholders.
‘Here, it is much more a case of strong performance driving up demand for the shares helped by exposure to technology companies,’ Hughes said.
More than a quarter of the portfolio is currently invested in the technology sector. One of the stand out performers on its books was Blue Prism (PRSM), which specialises in robotic software.
The UK stock, the second biggest holding in the trust at 8.75 per cent, listed in the AIM market in 2016 is now trading at more than double its flotation price.
Even more impressive is the performance of Fever-Tree the trust’s longstanding and top position at 12.05 per cent. The stock is trading at more than 20 times its flotation price and has been a significant contributor to the trust’s recent outperformance.
Over the past five years, the trust returned 223 per cent, against the FTSE All-Share gain of 45 per cent (to 1 June 2018).
Hughes said: ‘A couple of years ago, this trust was trading at a discount, but performance over the past 18 months has been excellent and share demand has picked up materially.
‘In addition, the board was active in buying back shares when they were trading at a discount, which helped drive the NAV up further.’