Many column inches have been devoted to discounts and premiums, although because investment companies in general tend to trade at a discount the emphasis has tended to be on the issue of the discount.
All this scrutiny is simply by virtue of the fact that it is possible to gauge the market sentiment towards an investment company, unlike with a regular trading company. Discounts have attracted both friends and foes to the sector over the years, perhaps in equal measure.
Discount volatility
Friends have been attracted because when you buy an investment company on a discount, you are still getting the full value of the underlying assets working for you to produce capital and income. And for investment company bargain hunters, if that discount subsequently narrows, this can enhance gains.
So for opportunists, investment company discounts can be very attractive. But it’s always worth remembering that discounts can widen as well as narrow - even if the share price goes up - and can hence also dilute gains. This is the counter argument.
The AIC has always maintained that it is not so much the absolute level of the discount that is the issue - which, at the time of writing, is at its lowest in four and a half years at an average of 7 per cent.
Rather, it is discount volatility that is the issue.
Whilst long-term investors may be happy to ‘ride out’ discount highs and lows in much the same way as they might with share price highs and lows, investment company board of directors have been increasingly using tools to help keep a floor to the discount.
In fact, around a third of the investment company sector now has a discount control mechanism in place, often with the caveat that this will apply in ‘normal market conditions’. Of course discount controls are not suitable for all, particularly those investing in illiquid assets.
A handful of investment companies now have ‘zero discount policies’, where the investment company aims to trade as close to net asset value as possible. This is achieved either by buying back shares when supply exceeds demand, or by issuing new shares when supply is unable to keep up with demand.
Premium concern
Indeed premiums - whilst clearly a sign of success - can equally cause concern because there is always the possibility that the premium may turn to a discount as soon as a company or sector falls out of favour.
So it is not surprising that investment company boards may monitor the level of the premium just as carefully as they might monitor the discount. Indeed many in income-focused sectors are currently in the enviable position of regularly issuing new shares in order to keep up with demand.
