A Premium to NAV (Net Asset Value) describes a situation where the market price of a fund's share is higher than its underlying value per share. Think of Net Asset Value (NAV) as the fund's “true” intrinsic worth on a per-share basis; it's calculated by taking the total value of all the fund's investments (Assets), subtracting any debts (Liabilities), and then dividing by the number of shares outstanding. The Market Price, on the other hand, is simply what investors are willing to pay for a share on the open market at any given moment. When investors are willing to pay $12 for a share whose underlying assets are only worth $10 (its NAV), that share is trading at a $2, or 20%, premium. This phenomenon is most common with Closed-End Fund (CEF)s because they have a fixed number of shares that trade on an exchange like a stock, allowing supply and demand to push the price away from the NAV. This contrasts with traditional Mutual Funds, which always transact at their NAV at the end of each day.
At first glance, paying more for something than it's technically worth seems foolish. Why pay $1.20 for a dollar's worth of assets? However, investors often have reasons—some logical, some less so—for bidding up a fund's price to a premium. The market isn't always irrational; sometimes, it's just pricing in factors that aren't captured in the simple NAV calculation.
One of the biggest drivers of a premium is a star fund manager. If a manager has a legendary track record of outperformance, investors may believe their skill will continue to generate superior returns. In this case, investors aren't just buying the current portfolio of assets; they are paying extra for the manager's brainpower and expertise, betting that their future genius is worth the upfront premium. High demand for a limited pool of shares in a popular manager's CEF can quickly drive the price above its NAV.
Some funds are like exclusive clubs, offering access to investments that are difficult or impossible for the average person to own directly. This could include:
In these cases, the premium can be seen as the entry fee for a unique investment opportunity. Investors are willing to pay more because the fund provides a convenient, one-stop-shop for an otherwise inaccessible asset class.
Sometimes, a premium is simply a sign of a hot trend or investor greed. A fund focused on a booming sector (like AI or clean energy) can get swept up in market euphoria, pushing its price to irrational highs. Another powerful driver is a high distribution yield. If a CEF is paying out a juicy monthly or quarterly income, yield-hungry investors might bid up the price to get a piece of that cash flow, often ignoring that the price they're paying is well above the value of the Underlying Holdings.
For a follower of Value Investing, paying a premium to NAV is almost always a red flag. The entire philosophy is built on the principle of buying assets for less than their intrinsic worth to create a Margin of Safety. Paying a premium is the literal opposite of this—it's paying more than the intrinsic worth, thereby creating risk instead of reducing it.
Buying a fund at a premium exposes you to two distinct layers of risk:
Imagine you buy a CEF at $12 when its NAV is $10 (a 20% premium). A month later, the manager has done a fine job and the NAV is still $10. However, the market sentiment sours, and the fund now trades at a 10% discount. The market price drops to $9. Even though the fund's assets performed perfectly fine, you've lost 25% of your capital ($3 per share) because the premium evaporated. This double-barreled risk is a key reason why value investors like Benjamin Graham would advise extreme caution.
As a prudent investor, your default position should be to avoid paying premiums. Look for funds that are trading at a significant discount to their NAV; this is where the real bargains are found. However, if you are ever tempted:
Ultimately, paying a premium to NAV is a speculative bet that the good times will keep rolling. A value investor prefers to bet on something much more reliable: buying a dollar's worth of assets for ninety cents.