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Discounts and premiums

Investment trust share prices rise and fall in line with demand from the market. However, the value placed on the shares by the market won't always be the same as the value of all the assets held by the investment trust and in fact it can be significantly different to the underlying value of the assets - the net asset value or NAV.

Let's say the assets of a trust, which has 5m shares in issue, are worth £8m. The market won't necessarily value each share at 160p which would be the price based on the NAV. They are far more likely to be trading at a discount or a premium to the NAV. If the shares are trading at 128p, they are said to be trading at a discount of 20 per cent and you are picking up 160p of assets for 128p. If the shares in this case though are trading at 164p, you are paying a premium. The most popular trusts – which might be in demand as a result of strong performance for example - often trade at a premium for long periods.

Investors who buy shares at a discount will be hoping the discount will narrow. Some trusts use discount control mechanisms to give investors confidence that the discount on a trust will not widen beyond a pre-specified level. They take different forms, including triggered share buy-backs or tender offers (if a discount breaches the target level), regular opportunities to redeem shares at or close to NAV, and regular continuation votes.

A widening discounts will reduce the value of your investment and if you need to sell, you will make a loss. Discount volatility is therefore a cause of concern for many investors who do not want the additional risk that their investments could suffer a double-whammy in a falling market. But if you're holding the shares as a long term investment, you needn't worry unduly about widening and narrowing discounts.

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