The net asset value (NAV) of a firm is the amount of money that would be left if it closed, sold its assets and paid its debts. This, divided by the number of shares in issue, gives you the NAV per share.
The NAV is often used to value firms with portfolios of instantly marketable assets, like property firms. Shares are referred to as trading ‘at a premium to’ (above) or ‘at a discount to’ (below) their NAV.
Real-estate investment trusts (REITS) tend to trade at less of a discount to the NAV than real-estate firms would on their own. This is because they allow firms to pool real estate assets that are worth more combined than individually, thereby spreading the risk of one project going wrong and offering predictable revenue.
Investment trusts are collective investment schemes. Similarly to open-ended investment companies (Oeics) or unit trusts, they allow investors to pool their money and invest in a wide range of companies, enabling them to spread their risk in a convenient way. However, there are some key differences between investment trusts (which are closed-end funds) and their open-ended peers.
Investment trusts are listed companies whose business is to invest in other companies. This means that they raise an initial amount of capital when they go public. After that, if you want to invest in the investment trust, you have to buy the shares in the open market. This is different to an open-ended funds, where any new money results in the creation of new units (and any sale results in the redemption of those units).
As a result, the value of the shares in an investment trust can vary from the value of the underlying portfolio (the net asset value – NAV). If the share price is higher than the NAV per share, then the trust is said to be trading at a premium. If the share price is lower, then it is trading at a discount.
This factor can present some interesting opportunities in investment trusts. If a trust trades at a discount of 10%, say, then it means you are effectively getting £1 worth of assets for 90p when you invest. This is more common than you might think. It’s worth putting a caveat here, however – the only way to benefit from buying at a discount is if the discount narrows and you then sell the shares at a profit. There is no guarantee that will happen, although increasingly trusts have “discount control mechanisms” whereby the board will commit to buy shares or even wind up the trust if the discount exceeds a certain level. Rather than looking at the absolute level of the discount or premium, the best bet is, instead, to compare it against the five-year average to see if it represents good value or not.