Internal Rate of Return (IRR) is the discount rate when the total present value of capital inflows is equal to the total present value of capital outflows and the net present value is equal to zero. If you do not use a computer, the internal rate of return needs to be calculated using several discount rates until you find the discount rate at which the net present value is equal to zero or close to zero. The internal rate of return is the rate of return that an investment aspires to achieve, and it is the discount rate that can make the net present value of the investment project equal to zero.
It is the rate of return that an investment aspires to achieve. The bigger the indicator, the better. Generally speaking, the project is feasible when the internal rate of return is greater than or equal to the benchmark rate of return. The sum of the discounted present values ??of the investment project's cash flows in each year is the project's net present value, and the discount rate when the net present value is zero is the project's internal rate of return. In project economic evaluation, depending on the level of analysis, the internal rate of return can be divided into financial internal rate of return (FIRR) and economic internal rate of return (EIRR).
At present, investment methods such as stocks, funds, gold, real estate, and futures have been familiar and used by many financial managers. However, many people's understanding of the effectiveness of investment is limited to the absolute amount of income, lacking scientific basis for judgment. For them, the internal rate of return (IRR) indicator is an indispensable tool.
The internal rate of return is the discount rate when the present value of the cash flow generated by an investment in the future is exactly equal to the investment cost, taking into account the time value, not what you think " No matter how high or low the net present value is, it is zero, so it doesn’t matter whether it is high or low.” This is an idea that puts the cart before the horse. Because the premise of calculating the internal rate of return is to make the net present value equal to zero.
To put it simply, the higher the internal rate of return, it means that the cost you invest is relatively small, but the benefits you get are relatively large. For example, the investment costs of A and B are both RMB 100,000 and the operating period is 5 years. A can earn a net cash flow of RMB 30,000 per year and B can earn RMB 40,000. Through calculation, it can be concluded that A's internal rate of return is approximately equal to 15%, B's is approximately equal to 28%, these can actually be seen through the annuity present value coefficient table.
When using the internal rate of return method to make investment decisions, the decision criteria are: if the IRR is greater than the minimum investment rate of return or capital cost required by the company, the plan is feasible; if the IRR is less than the minimum investment rate of return or capital cost required by the company, , the plan is not feasible. If it is a comparison of multiple mutually exclusive plans, the higher the internal rate of return, the better the investment benefit. The advantage of the internal rate of return method is that it takes into account the true rate of return of the investment plan and the time value of funds; the disadvantage is that the calculation process is relatively complex and cumbersome.
What kind of baton is waving behind the high discount rate of closed-end funds? The market is also constantly looking for the reasons and values ??behind this.
Why has the discount rate reached a new high?
From the perspective of external performance, it is attributed to the two major out-of-synchronizations between fund net value and price, and prices between funds of different sizes. First, the fund's net value is out of sync with the secondary market price, and the secondary market price performance lags behind the increase in the net value. Second, the prices of funds of different sizes are out of sync. Although the net value of funds has risen to a certain extent recently, because most large-cap funds have far-out maturity dates and small-cap funds have closer expiration dates, the liquidity of funds of different sizes varies greatly, and the market performance is very different.
From the perspective of internal factors, it is attributed to system flaws, management flaws and lack of arbitrage opportunities. System deficiencies and management deficiencies mainly include the different operating mechanisms of closed-end funds and open-end funds, which are prone to moral hazard; the unwritten "priority trading principle of open-end funds"; the intensified institutional characteristics of fund holders leading to insufficient liquidity, etc. The lack of arbitrage opportunities is the theoretical explanation for the gradual marginalization of closed-end funds and the rising discount rate. The inability to redeem closed-end funds during their duration and extremely poor liquidity greatly hinder the smoothness of the arbitrage mechanism, leading to long-term deviations between transaction prices and net values.
High discount ≠ high value, low dividend rate ≠ low value
The investment value of closed-end funds is determined by four major factors: performance, discount rate, duration and maturity arrangement. A high discount rate without considering the other three factors cannot explain its investment value. It can only be said that theoretically speaking, the ultra-low price under the high discount rate has certain market investment opportunities, and the huge gap between the market price and the net value makes the risk relatively small. Because the net value of some closed-end funds has been lower than the face value for a long time, the dividend rate is generally low, most of which are below 1%. Only Fund Kerui has better operating performance, ranking first with a dividend rate of 13.04%. However, combined with the high discounts of closed-end funds, funds with the ability to pay dividends have greater value. Because of the high discount, buying a closed-end fund is equivalent to directly buying market stocks at a 30% to 30% discount, and its dividend rate will be amplified.
The internal rate of return reveals the value of the fund
Theoretically, as a closed-end fund approaches maturity, its price will move closer to its net value. Then, it is possible to obtain higher investment returns by investing in closed-end funds, which are currently generally priced at high discounts. Therefore, assuming that the net value remains unchanged, the internal annual rate of return indicator is introduced, and the closed-end fund is absolutely valued based on the income obtained from liquidation at maturity. The valuation method uses the cash flow discount method to calculate the investment value during the return of the fund price to the net value. .
Statistics show that the internal rate of return indicator is highly correlated with duration, fund shares and discount rate. Small-cap funds with a short duration have a discount rate of 12%-25% and a higher internal rate of return; conversely, large-cap funds with a longer duration have a discount rate of 35%-47% and a lower internal rate of return.