/ GEARING & DISCOUNTS / where the reverse is true and the underlying securities are worth less than the total shares in existence .
Buying at a discount and then selling at a premium or a tighter discount can mean an extra layer of profit on top of any appreciation in the value of the underlying securities or the income that they pay out .
Sometimes , the reason why discounts are so large can be because the area the trust focuses on is out of fashion – as was the case with commodities 18 months ago . Morgan says this is often the best time to invest .
Discounts can go for extended periods of time without showing much movement , however , and can grow wider before they eventually narrow , says Evan-Cook . Investors have to be particularly careful about buying a trust on a premium as any losses will be amplified if it subsequently moves to a discount , as was the case with Fidelity China Special Situations .
This trust received enormous attention when it was launched in April 2010 , due to the involvement of star manager Anthony Bolton , and at one point its premium reached 13.1 per cent . The board of directors were so concerned this figure would put off new investors that they issued C shares in a bid to bring it under control .
STRUGGLING TO COPE However , Bolton failed to replicate the spectacular performance he delivered while at the helm of the Fidelity Special Situations fund , struggling to cope with the difference in corporate governance between the UK and China .
When the trust ’ s net asset value ( NAV ) began to decline , the trust moved from a premium to a discount – this reached more than 23 per cent at one point . The
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Source : FE Analytics
PRICE VS NAV OF TRUST SINCE LAUNCH
Fidelity China Special Situations - NAV ( 207.11 %)
Fidelity China Special Situations - price ( 178.7 %)
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May13 trust ’ s maximum drawdown – the most investors would have lost if they bought and sold at the worst possible moments – stands at 42.21 per cent since launch .
“ If you are looking to make a fast buck and you have an itchy trigger finger , investment trusts could end up losing you more than they make you ,” Evans adds .
If you can find a reason that suggests the size of the discount is unjustified , you may be on to a winner . Like the fund manager gearing up the portfolio , however , this requires conviction and you must always beware of the risks .•
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