Henderson Smaller Companies trust, a member of our First 50 Funds for beginners, is trading at a -14% discount, meaning it could be a bargain buy for a long-term investor.
The 14% discount effectively means that investors are buying £100 of assets in the trust for just £86, plus any trading fees incurred when buying.
Smaller companies funds are sometimes overlooked by investors in the UK market, who prefer to gain exposure to big British success stories such as GlaxoSmithKline or Vodafone. They are higher risk because they can be more volatile than larger companies but they have greater potential for growth over the long term. Most long-term investors are therefore advised to have some smaller companies exposure in their portfolios.
Gavin Haynes, managing director at wealth management company Whitechurch Securities, says: “UK smaller companies have fallen out of favour due to Brexit concerns and this has seen widening discounts, which has hurt price performance. However, it could provide an attractive entry point for long-term investors.”
Monica Tepes, investment company analyst at Cantor Fitztgerald says: “Despite great track records and strong management teams, the sector is on double-digit discounts. It’s the most consistently unwarrantedly unloved sector in my view.”
What does trading at a discount mean?
Investment trusts have a two-tiered pricing system, involving both the share price paid by investors and the trust's net asset value (NAV) (the total value of a company's assets minus the total value of its liabilities), there's an additional factor to consider – the share price's discount or, more rarely, premium to NAV.
The trust is trading at a premium when the share price rises above the NAV and it is trading at a discount when the share price falls below the NAV.
Over the longer term, discounts tend to stabilise, so a wider than average discount may indicate either a trust with problems – the share price is low because no one wants it – or an opportunity for bargain hunters, as short-term returns will be boosted if the discount returns to its usual range.
Most investors steer clear of buying at a premium because premiums don't tend to be sustainable. It's likely the gap between share price and NAV will close again and those who bought at a premium will lose money.
But there may be times when a sector is particularly popular, and those trusts attract investors despite their premium rating.
In most cases, discounts and premiums are not that significant for long-term investors, although it's good to buy when a trust is on a wider than usual discount, as it's likely to narrow back towards its long-term average and help your returns.