Discount to Net Asset Value

Discount to net asset value (NAV) is a pricing situation that occurs when a fund’s market trading price is lower than its net asset value. Discounts can occur in times where the market has a pessimistic future outlook on the underlying mutual fund holdings. Other factors may also influence a mutual fund discount.

A discount to NAV can occur with closed-end mutual funds and exchange-traded funds (ETFs). Both of these investments trade on the open market and calculate a daily NAV. A discount to NAV occurs when the market trading price is lower than the most recent NAV. A discount often indicates the market is generally bearish on the investments in the fund and the fund company’s potential to generate returns.

The net asset value of a fund is calculated after the close of each trading day. It is considered a forward price NAV since it accounts for all transactions that have occurred since the previous day’s price calculation. The net asset value is the value of the fund’s total assets at market close minus the fund’s liabilities divided by the total number of shares outstanding.

Closed-end funds and ETFs trade on exchanges with transactions occurring at a market value. The market value is an arbitrary price that is determined by market participants. When the fund trades above its last quoted NAV it is trading at a premium. When it trades below its last traded NAV it is trading at a discount. Fund companies often provide historical records of a fund’s premium and discount trading.

A fund trading at a discount to NAV offers an opportunity to profit. Fund’s can trade at a discount for many reasons. Closed-end funds tend to trade with higher volatility from their NAV than ETFs because ETFs have authorized participants that actively follow the shares and take action to reconcile the price in the open market when it deviates from the NAV. Closed-end funds do not have such mechanisms and offer greater opportunities for arbitrage.

In many cases a premium or discount may be due to slight variations in the market pricing of the securities within the fund. The NAV is calculated once per day while the securities trade nearly 24 hours a day around the world. A discount signals that market investors find the securities in the fund to be valued below their comprehensive NAV value. This can occur throughout the day from bid and ask spread variance. The price of underlying securities may also be falling. Additionally, market news can also effect the price of securities before it is factored into the next NAV.

Closed-end fund values typically do not deviate far from their NAV since the funds are backed by their underlying holdings. Fund managers can buy back shares to restore the fund’s NAV. If a discount does occur, investors can profit from the discounted price and also gain yield benefits from a lower price on income paying securities.

Most closed-end fund managers report both the day’s market price and NAV in their marketing materials. They also often provide historical records of premium and discount market levels versus NAV. The Guggenheim Enhanced Equity Income Fund provides one example. On December 13, 2017 the fund’s market price was $8.97 versus the NAV price of $9.15. The Fund reported a -1.97% discount. As of December 13, it also reported a 52-week average discount of -4.04%.