Definition
A discount to NAV (Net Asset Value) is a situation that arises when the market trading price of a mutual fund or exchange-traded fund falls lower than its net asset value (NAV). The net asset value is the value of an investment fund or trust minus its liabilities divided by the outstanding shares. It is also the price at which shares of the funds are traded on different exchanges.
What is the significance of investing in an investment trust trading at a discount to NAV?
Investing in an investment trust trading at a discount to NAV saves investors money and can even help them purchase more trust units if they have a fund. If the discount is significant enough, the amount an investor saves or has left over to invest in the trust increases, and they can buy more as long as someone is willing to sell to them at the discounted price.
How can investors take advantage of this?
Buying more of the investment trust is the best way to take advantage of a price discount. If the underlying assets and securities have had a strong performance for a long time, a significant dip causing them to trade at a discount to NAV is a massive advantage. The reason is that investors can be confident the price will return to its previous higher level, and the difference in the two prices is where the profit lies.
What factors contribute to an investment trust trading at a discount to NAV?
The underlying factor for an investment trust trading at a discount to NAV is the lack of investor faith in that trust. Investors might rightly or wrongly think that the securities included in the trust are not as valuable as their NAV indicates, and thus, they start trading at a discount compared to it.
It can also happen when there is a significant bid-ask spread variance, which tells the relationship between the asking and bid prices. If the asking price is higher than the bid price, investors are unwilling to pay as much as the seller is asking for, so the seller has to lower their price if they want that sale.
The last factor is industry news. Since NAV changes at the end of the day, any news during the day and before the closing of trading can cause the shares of a company in a trust to decrease, leading to a decrease in the overall price of the trust in that instance. Between then and when the market closes, the trust will trade at a discount to NAV.
What are the potential risks and benefits of investing in an investment trust trading at a discount to NAV?
The most significant risk is the discount to NAV being an indicator of the start of a period of poor performance rather than a blip on a chart. Investors can only know if this is the case once the market closes and a new NAV is announced, which means they would have bought a trust that will go down from here on out.
The key benefit is the massive potential for profits if the discount is significant enough. The other is positions opening up that otherwise would not have, allowing investors to put money in areas they previously could not access due to the cost of a trust or fund.
What are the reasons for an investment trust trading at a discount to NAV?
The main reason for trading at a discount to NAV is investors not having faith in the future outlook of the assets in the trust.
A discount to NAV happens when the market price of a trust or fund falls below its net asset value, giving investors interested in it an opportunity to invest. It is a good idea for investors to do their due diligence to ensure the discount they are seeing is not an indicator of a bigger issue with the trust or fund.
