For investment trusts trading on a high premium – 5% or higher as a rule of thumb – it is generally not a good idea to buy because such premiums tend not to be sustainable over the long term.
It has become customary at the start of a year for commentators to pick out the investments they believe look well-placed to deliver the goods in the coming year – our Wealth Creation guide, published in January, being a good example.
Some of the funds, investment trust and share tips in January's magazine were influenced by the wider macroeconomic backdrop, while others were selected on valuation grounds.
While commentators have a stack of ‘buy’ ideas, they are reticent to issue ‘sell’ recommendations, perhaps because of concerns that they may be more likely to end up with egg on their face if the investment in question surprises on the upside.
For funds, weighing up whether to sell is more of an art than an exact science, but one of the main triggers is when the investment process is flawed. This, though, is difficult to spot before the fund has actually started to underperform.
In the case of investment trusts, the closed-ended structure makes it much simpler to find examples where there is arguably a case for selling. As trusts trade either on a premium or a discount to net asset value, an investor will either pay more or pay less than the underlying assets are worth.
For trusts trading on a high premium – 5% or higher as a rule of thumb – it is generally not a good idea to buy because such premiums tend not to be sustainable over the long term and can turn into a discount when conditions change. Instead, a more prudent approach is to wait for the premium to cool.
There are various reasons why a trust trades on a high premium, but more often than not it is down to the assets in which it invests being fashionable or popular. Therefore, as well as paying over the odds, investors risk buying either at or near to a peak.
One way to assess whether the premium looks unjustifiably high is to compare its premium with its one-year high and one-year low figures. Our table below, which highlights 12 trusts with premiums of 5% or more, shows there are three investment trusts trading on premiums that are within a whisker of their one-year high: CC Japan Income & Growth, Henderson Far East Income and GCP Infrastructure Investments.
Moreover, the respective three-month change figures show that each trust has moved onto a pricey premium relatively recently. In the case of CC Japan Income & Growth and Henderson Far East Income, both were trading virtually at par three months ago, but are now carrying loftier price tags. In addition, GCP Infrastructure Investments, which was three months ago already on an arguably ‘too hot to handle’ premium of 10%, has become around a third more expensive.
In our pricey premium table, three key themes are apparent. The first is that a number of trusts on high premiums produced stellar performance in 2018. Lindsell Train Investment Trust stands out in this respect, having been the top-performing investment trust overall over the course of the year. Other trusts among the top performers of 2018 include Doric Nimrod Air Two and Doric Nimrod Air Three.
The second theme is the high demand for defensive assets, with investors adopting more of a pessimistic stance. As a result, RIT Capital Partners, the conservatively positioned trust, has seen its premium expand from 6.3% to 8.4% over the three-month period. Infrastructure trusts have also been high in demand, with investors attracted to the asset class’s safe-haven qualities.
The final trend is the spate of new trust launches that has occurred of late. It is not uncommon for a new trust to trade at a premium, but care should be taken not to pay over the odds.
|Trust||Premium to net asset value (%)||Three-month change (%)||One-year low (%)||One-year high (%)|
|CC Japan Income & Growth||7.2||6||-1.1||7.4|
|Henderson Far East Income||5.8||4.8||-3.4||6|
|GCP Infrastructure Investments||15.2||4.5||4.2||15.6|
|Doric Nimrod Air Three||49.8||4.4||26.8||52.4|
|RIT Capital Partners||8.4||2.1||0.7||11.9|
|Doric Nimrod Air Two||23.9||2||8.9||25.8|
|AVI Japan Opportunity||6.3||n/a||n/a||n/a|
Notes: Table shows a selection of investment trusts that have seen their premiums increase over the past three months. Constituents ranked by three-month change. Trusts with n/a under three-month change do not yet have a three-month track record. Source: Morningstar, as at 31 December 2018.