This is because investment trusts have two values: the amount the trust itself is worth (the net asset value or NAV), and its share price. When the share price is lower than the NAV per share, the trust trades at a “discount”.
A discount to NAV surfaces when the market trading price is lower than the most recent NAV. A discount often indicates the market is generally bearish on the investments in the fund and the fund company's potential to generate returns. The NAV of a fund is calculated after the close of each trading day.
According to the noise theory, fluctuations in departures from NAV are caused by changes in investor sentiment. That is, when investors become (irrationally) pessimistic about REITs, the value of REIT shares is pushed below their true, underlying value.
An ETF may not match its NAV for many reasons. One common reason US-listed ETFs investing in international stocks may trade at premiums or discounts is time zone differences.
If investment trust shares are trading at a discount to NAV it can give the impression that the shares are cheap because the fund isn't worth investing in. Although this isn't always the case, boards don't want investors to be put off by a discount that is too wide.
Since market prices are ruled by supply and demand, an ETF's market price can diverge from its NAV. If there's heavy demand from buyers, the price of an ETF can increase above its NAV (a premium). Conversely, if there's heavy sell-side pressure, the price can dip below the NAV (a discount).
By contrast, mutual funds always trade at NAV, without any bid/ask spreads.
A real estate investment trust (REIT) can be analyzed using net asset value (NAV). NAV is used instead of price-to-book ratios and other book value measures. NAV measures the actual value of the REIT's holdings by taking the market value and subtracting any debts, such as mortgage liabilities.
Higher interest rates can also make REITs less attractive compared to other income-generating investments, such as bonds. Taxed as ordinary income: Dividends from REITs are typically taxed as ordinary income, which can result in a higher tax burden for investors, especially those in higher tax brackets.
Conversely, a fund may be trading at a discount due to poor fund performance, or low distribution levels relative to peers or to market expectations.
Key investment trust terms
Net Asset Value (NAV): the total value of the investments held by the trust, minus any money it has to pay out (liabilities) then divided by the number of shares.
When investing in mutual funds, NAV is not a meaningful indicator of the fund's future performance or suitability. Whether a fund has a high or low NAV should not be the primary factor in your decision-making process. Instead, focus on: Fund consistency in performance over different time periods.
However, as interest rates rocketed and demand for alternative sources of income plummeted, these investment trust sectors seriously sold off, causing share prices to plunge and move to deep discounts to underlying net asset values (NAVs).
"At a discount" is a phrase used to describe the practice of selling stocks, or other securities, below their current market value, similar to a sale of goods at a retail establishment.
The basics of premiums and discounts
When the market price of a CEF is above its net asset value (NAV), the fund is said to be trading at a premium. Conversely, when a fund's market price is below NAV, the CEF is trading at a discount.
Warren Buffet prefers to invest in REITs instead of real property because they are a great source of passive income, are reward-oriented, and are more liquid than property ownership.
When dividends are reinvested, the shareholder gets more shares or a fraction of an additional stake in place of cash. The NAV decreases by the amount distributed, while the total value of the investor's fund investment remains unchanged.
REITs median premium to NAV in the U.S. 2019-2024, by property type. As of February 2024, many different types of REITs in the United States traded with a discount to the NAV. On average, U.S. REITs traded with median discounts of 15 percent.
The 30-day rule refers to a regulation that applies to mutual fund purchases and sales. Under this rule, mutual fund investors who sell shares of a mutual fund and then purchase shares of the same or a substantially similar mutual fund within 30 days are not allowed to claim a loss on their tax return.
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It provides investors a reference point around which they can gauge any offers to buy or sell shares of the fund. If you own 100 shares of an ETF whose NAV is $50, and someone offers $55, you have a solid basis from which to judge their offer.
Discount to NAV – The amount by which the net asset value (NAV) exceeds the share price, calculated as the share price divided by the net asset value and expressed as a percentage.
Track record: A fund's historical performance can significantly influence investor sentiment. Consistently outperforming funds may trade at a premium, while underperforming funds may trade at a discount. Reputation: The reputation of the management firm and individual fund managers can impact the fund's price.
Similarly, when a futures contract is trading below the spot price, it is said to be at a Discount in the equity derivatives market and Backwardation in the commodity derivatives market. For example, Stock. Market/Spot Price. Futures Price.