Investment Trusts & Discounts from NAV

Investment Trusts are structured as companies, with a fixed number of shares issued at launch. These shares are freely tradable on the stock market, and unlike open-ended funds, their prices are determined by supply and demand, not just the value of the underlying assets.

The company raises capital by issuing shares, and this cash is then invested in a portfolio of assets—most commonly equities. However, the closed-ended structure of investment trusts also makes them well-suited to holding more illiquid investments, such as private companies, infrastructure, and property, which might be harder to manage in open-ended funds.

Because the capital base is fixed, investment trusts are known as closed-ended funds. In contrast, open-ended funds (e.g. Unit Trusts) issue and redeem shares daily to match investor inflows and outflows, which means their fund size can grow or shrink dynamically and their unit price always closely reflects the portfolio's value.

In investment trusts, however, share prices float freely, and can diverge from the value of the underlying portfolio. This is where the concept of a discount or premium to Net Asset Value (NAV) comes in.

NAV is the value of the trust’s assets minus its liabilities, divided by the number of shares.

But note: This NAV is based on market value, not traditional book value.

It reflects what the trust's holdings—like listed equities or estimated values of private companies—could be sold for on the open market, not what those companies are worth on their balance sheets.

This creates an interesting quirk: investors can sometimes buy a trust’s shares at a discount, effectively purchasing £1 worth of assets for, say, 90p.

For example, a trust trading at a 10% discount to NAV offers access to the same underlying portfolio at a reduced price.

But beware: discounts exist for a reason. The average investment trust currently trades at a 14% discount, and trusts have been at double-digit discounts for the past 2.5 years. That said, history shows that buying at wide discounts has often led to strong returns over five-year periods, especially if sentiment improves or the discount narrows. Any bullish catalyst for the UK market could dramatically increase the value of the underlying shares. Investors then typically pile into these funds, bringing NAV back to par or pushing it into a premium.

Why the Structure Matters

The fixed capital base gives investment trust managers greater freedom than their open-ended counterparts. They don’t need to worry about investor redemptions, so they can:

• Hold less liquid assets.

• Invest with a long-term view, even in volatile markets.

• Buy when others are forced to sell—a potential edge during market downturns.

Additionally, investment trusts can borrow to invest (known as gearing (leverage)), potentially enhancing returns (and losses) depending on market direction.

Trusts are also governed by an independent board of directors, whose job is to protect shareholder interests and oversee the portfolio manager. If the board loses faith in the manager, it has the power to replace them—an added layer of accountability that doesn’t exist in most open-ended funds.

Finally, investment trusts can smooth income through a revenue reserve. They can set aside a portion of income each year to maintain a more stable dividend, even when the underlying portfolio has a bad year.

If you're curious about how this all works in practice, check out LSE:INPP (International Public Partnerships) — a trust that invests in infrastructure and currently trades at a discount.