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What Is A Discount?

 What Is A Discount?

Click here to go forward to the Managing The Discount Section
Click here to go back to the Net Asset Value (NAV) section
Click here to return to Investment Companies – Part Two
Click here to return to Investment Companies – Part One

The discount is the amount by which the share price is lower than net asset value, expressed as a percentage. In plain terms, it is a measure of the popularity of an investment company.

Shares in investment companies often trade at a price different from the value of the underlying net assets. If the net asset value per share is higher than the share price, an NAV discount is said to exist. If the NAV is lower than the share price, the shares are said to trade at a premium to NAV. Shares in less popular investment companies trade at a discount to NAV. Popular investment companies’ shares trade at a premium. Likewise, if expectations are that the company will do well in future, the shares are likely to trade at a premium to NAV. If the opposite is true, a NAV discount is likely.

The price of shares in any quoted company, like the price of apples or tomatoes, is determined by supply and demand. On the supply side, the number of investment company shares is usually fixed. If the supply of shares exceeds demand, the price is likely to fall to a NAV discount. If demand exceeds supply, the market price of shares is likely to be at a premium above NAV.

Investment companies worry more about their popularity than most companies. If an investment company trades at a big discount to the value of its assets for some time, large numbers of shares could be bought with the aggressive intention of winding the company up. After all, a profit will come to an investor who buys at a discount and sells at or near net asset value. Persistent wide discounts therefore pose a danger to the survival of an investment company and are a big reason why investment companies are concerned with their popularity.

 Bargains

Investment companies trading on wide discounts may look like bargains but this can be misleading. There is often a good reason for the discount.
Big premiums can be problematic too. If investors lose faith in a popular investment company, the premium can quickly turn into a discount. This will make it look as though the investment company is doing badly and could trigger more selling.

Discounts that swing around too much can also be dangerous. Investors might catch the swing right, buying at a wide discount and selling at a narrow one. However, more commonly investors get sucked into buying a fund because it is popular and then get disheartened and sell when it is unpopular.

Click here to go forward to the Managing The Discount Section
Click here to go back to the Net Asset Value (NAV) section
Click here to return to Investment Companies – Part Two
Click here to return to Investment Companies – Part One

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