A reader asks why investors are buying an investment trust on a huge premium. We take a closer look.
Can you explain how Lindsell Train (LSE:LTI) can trade at a premium of 75% above net asset value (quoted on interactive investor's website in mid-April)? Does this effectively mean investors believe the fundamental investments this trust has already made will be worth 75% more, within a reasonable timescale? Why would, or should, anyone pay such a premium?
We all expect our investment trust investments to grow over time but, in general, only pay a price close to net asset value in expectation of this.
Clearly Lindsell Train are very good investment managers and I would like to use their skills, but how can I believe and justify to myself that it is worth paying 75% in excess?
If the information were not so transparent, it would sound like a scam.
Geoff E, via email.
Kyle Caldwell, deputy editor of Money Observer, replies: as at close of trading on 7 May, the premium is a tad higher, at 85%, which means the share price of the trust is almost double the underlying value of the investments held in the trust. LTI is a rare case of an investment trust that almost always trades on a sky-high premium; the last time it traded on a discount was around a decade ago, following the global financial crisis.
The trust commands such a high premium largely because of its largest holding – Lindsell Train Limited, the fund management business that runs the investment trust and was established in 2000 by Michael Lindsell and Nick Train. This position is chunky, representing 45% of the investment trust's assets. As Ben Yearsley, of Shore Financial Planning, explains, investors think it is worth paying a substantial premium for LTI on the assumption that the unquoted fund management business’s valuation has been undervalued by the investment trust.
"It is sort of self-fulfilling - if the investment trust does well, Lindsell Train Ltd gets more fees, benefiting the holding in the investment trust. Unquoted companies only get revalued a few times a year and therefore the next time this happens it is likely the fund management arm will get revalued if it has higher assets under management and is collecting more money from investors in the form of management fees." The assumption that the fund management business is undervalued is therefore rooted in its future success, meaning that strong long-term performance from the investment trust and Lindsell Train's open-ended funds will need to continue.
But for investors buying LTI today, an 85% premium looks very excessive, particularly when it has typically traded around the 20% to 30% premium range over the past couple of years. Even these levels are too high, acknowledges trust manager Nick Train. He took the unusual step of advising investors in October 2012 to not buy LTI when it was trading on a premium of just over 20%, acknowledging that high premiums do not tend to be sustainable and will reduce over time towards the trust’s net asset value. Over the past year, LTI has traded on a premium of 47%.
Adrian Lowcock, head of personal investing at Willis Owen, says investors should avoid LTI. "No matter how good the managers are, investors should remember a few things – premiums can vanish quickly and it is rarely wise to overpay for something, as the price you pay will affect long-term performance. Also, while Nick Train and Michael Lindsell are excellent fund managers, they have an investment style, and like any fund manager that investment style can go out of favour and performance can lag for potentially long periods, although given their long-term focus this wouldn't be a concern in the short term." Another danger is 'key man' risk, as both Train and Lindsell are named managers on all the investment trusts and funds in Lindsell Train's stable.
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