Discount to NAV

Discount to NAV (also known as a 'Discount to Net Asset Value') is a situation where the market price of a fund's share is lower than its underlying value per share. Think of it like this: imagine a shopping basket filled with €100 worth of carefully selected groceries. This €100 is the basket's Net Asset Value or NAV. Now, what if you could buy that entire basket at the checkout for just €80? You'd have bought it at a 20% discount to its NAV. In the investment world, this happens with certain types of funds, most notably Closed-End Funds (CEFs) and sometimes Exchange-Traded Funds (ETFs), which trade on a stock exchange like regular company shares. Their price is set by the moment-to-moment whims of supply and demand, not just by the calculated value of what's inside. A discount, therefore, is the percentage difference between the fund's higher “true” value per share (its NAV) and its lower trading price on the market. It represents a potential bargain, but one that requires a closer look.

Unlike a traditional Mutual Fund, where you always buy and sell shares directly from the fund company at the day's closing NAV, CEFs have a fixed number of shares that trade between investors on the open market. This creates a separate market price that can, and often does, drift away from the NAV. Several factors can push the price down, creating a discount:

• Management Fees and Expenses: The market is often forward-looking. Investors might price a fund's shares lower to account for the future drag of management fees on performance. A fund with high fees is more likely to trade at a persistent discount.
• Poor Performance or Strategy: If a fund manager has a poor track record or invests in an unpopular sector, investor demand will wane, pushing the share price down regardless of the underlying asset value.
• Illiquid Holdings: If a fund holds assets that are difficult to sell quickly without a price drop (like certain private equity or real estate holdings), investors may demand a discount to compensate for this lack of liquidity.
• General Market Sentiment: In a bear market or during a panic, fear can drive down the price of everything, including well-run funds, creating or widening discounts across the board.
• Use of Leverage: Funds that borrow money to invest (leverage) can see their discounts widen during market downturns, as investors fear that losses will be magnified.

For a value investor, a discount to NAV can be music to the ears. It's the classic “buy a dollar for 80 cents” scenario that the legendary Benjamin Graham famously advocated. The appeal is twofold and represents a powerful potential Margin of Safety:

• Buying Assets for Cheap: You are purchasing a share in a portfolio of stocks or bonds for less than their collective market value. If the fund holds high-quality assets, you're getting a bargain on the underlying holdings.
• The “Double Whammy” Return: Your investment can profit in two ways. First, if the value of the underlying assets goes up. Second, if the discount itself narrows or disappears as market sentiment improves. If both happen, it can lead to spectacular returns.

However, a discount is a starting point for research, not an automatic buy signal. A fund full of terrible businesses trading at a 30% discount is likely a Value Trap—a cheap asset that deserves to be cheap and will likely stay that way. The crucial step is to lift the hood and inspect the engine: Are the assets inside the fund something you would want to own anyway? If the answer is yes, then buying them at a discount is just the cherry on top.

Calculating the discount is straightforward. You just need the fund's NAV per share and its current market price, both of which are usually available on the fund's website or major financial news portals. The formula is: Discount (%) = ((NAV per Share - Market Price per Share) / NAV per Share) x 100

Let's say the “Euro Stars CEF” has the following stats:

• NAV per Share: €25.00
• Market Price per Share: €22.50

The calculation would be:

1. ((€25.00 - €22.50) / €25.00) x 100
2. (€2.50 / €25.00) x 100
3. 0.10 x 100 = 10%

The “Euro Stars CEF” is trading at a 10% discount to its NAV. As an investor, you'd compare this 10% discount to the fund's historical average and to its peers to see if it represents a genuine opportunity.

Be warned: some funds seem to be on a permanent sale. They trade at a significant discount year after year, and the gap never closes. This is often called a “perma-discount” and is a classic sign of a value trap. This usually happens for a good reason, such as chronically high fees that erode returns, a consistently underperforming manager, or a strategy that is permanently out of favor with the market. Buying into such a fund in the hope that the discount will narrow is often a fool's errand. The key is to investigate why the discount exists. Is it due to a temporary market overreaction that you can profit from, or is it a sign of a permanent flaw in the fund itself? The answer to that question separates a smart investment from a costly mistake.