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I'm thinking about buying Edinburgh Invest Trust because of its yield,managers and hopefully some upside. It is currently trading at a small discount but the discount graph on http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=I...
reveals that the average discount for the last 5 years has been in the region of 18% which is putting me off. Is this high discount correct and why is it so large?
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Is this high discount correct and why is it so large?

Because of its high debt.

McEssex
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It is correct. You're right to be put off.

First a point on how Trustnet measures discount/premium to NAV. Trustnet's figures measure NAV with debt at par (nominal) value whereas others, including the AIC, measure debt at fair (market) value. For investment trusts with little or no debt this makes little difference. Edinburgh IT just so happens to be one of the most indebted investment trusts out there [1]!

The level of debt, via debenture stock, outstanding at Edinburgh leads to a large swing in discount/premium depending on how you value the debt. An idle look at the AIC's website ([2]) currently shows a premium of nearly 10% while Trustnet shows a small discount. The AIC figure itself is misleading, imho, since it doesn't take into account accumulated income. Edinburgh IT release NAVs daily based on par and fair value, cum and without income [3]. If this is all rather confusing the AIC have a good explanation of net asset values on their website [4].

Using March 11th as an example the Edinburgh share price finished the day at 297p, the following day Edinburgh released NAV figures that were between 270.71p and 318.39p, quite a difference! Personally I use the debt at fair value and cum income (for income ITs where this is going to skew the figure). For Edinburgh this was 282.06p on March 11th, still a premium of 5.3%.

So why the drastic reduction in discount for Edinburgh recently? Three factors stand out for me:

1. The appointment of Neil Woodford as fund manager.

2. The protection of income, in the short-term at least, that most Investment Trusts offer as they have a revenue reserve.

3. The structural advantage that a discount to NAV offers to the underlying yield - if you buy on a 10% discount you're effectively buying a 10% higher underlying dividend (excluding charges).

2 & 3 can be applied to all Growth & Income investment trusts and most are now trading at a premium to NAV for these reasons. Personally I think its a little silly buying an Investment Trust on a 5% premium when, once the stockmarket recovers, you're likely to see that premium become a 10% discount. For those reliant on a steady and increasing income such as retirees the peace of mind may be worthwhile but even then its difficult to justify.

I'd avoid Edinburgh right now. The downside risk is far higher than buying into Woodford's Invesco Perpetual (High) Income funds which don't have the leverage and aren't in danger of reverting back to a high discount to NAV.

mm

[1] See pages 45-47 of the EDIN annual report available at:
http://investmenttrusts.invescoperpetual.co.uk/portal/site/i...

[2]AIC's pricing for EDIN:
http://www.theaic.co.uk/Search-for-an-investment-company/Com...

[3]EDIN NAV news releases:
http://www.theaic.co.uk/en/Search-for-an-investment-company/...

[4] The AIC's explanation of NAV:
http://www.theaic.co.uk/en/Guide-to-investment-companies/Glo...
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[Quote] 2 & 3 can be applied to all Growth & Income investment trusts and most are now trading at a premium to NAV for these reasons. Personally I think its a little silly buying an Investment Trust on a 5% premium when, once the stockmarket recovers, you're likely to see that premium become a 10% discount. [End Quote]

Indeed, but apparently there are still some investors willing to buy them at current premium prices. For recently I’ve began to notice several such reasonably debt free Growth & Income ITs taking the opportunity to release into the market relatively small parcels of shares either out of accumulated treasury holdings or as fresh issues of equity. I suspect that this is being done in order to satisfy specific market demand from either individual investors and / or the market makers in these shares.

It certainly makes sense that no matter how far share prices and their underlying NAVs have fallen of late. If there is still a select demand for the shares of reasonably yielding investment trusts in a near zero interest rate environment then why not take the opportunity to dribble out parcels of shares into the market while the factor of discounts ceases to be of immediate concerns.

This whole question of indebtedness measured by either par or fair market value is sometime that in practical terms doesn’t really concern me. For it is something that for the last 10 years I’ve deliberately avoided like the plague. Being that I’ve purposefully swerved every investment trust that has balance sheet borrowings that can’t be repaid at a moments notice. If a trust can roll-out debt then I want to know how fast a manager can roll it in again if needs be.

While I’m quite willing to accept borrowings imposed on share structures such as that of ZDP shares effectively forfeiting any revenue rights to lower ranking Income Shares in return for a predetermined capital payback schedule. In the interests of both capital and income stability, I’m not prepared to tolerate debt on underlying balance sheets as well. I can have either share structure debt or balance sheet debt – but I’m not going to put up with both of them.
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