Investment Trusts Explained
What is an investment trust?
An investment trust is a type of fund, listed on the stock exchange as a public limited company, that seeks to make money for its shareholders by actively managing a portfolio of assets.
What are the key features of an investment trust?
Closed-ended
Unlike unit trusts and OEICs (open-ended investment companies), investment trusts have a fixed number of shares in issuance at any one time.
In contrast, unit trusts and OEICs continue to issue new units in response to demand, meaning it can expand or contract as investors move their money in and out, while an investment trust remains intact.
This gives investment trusts the flexibility to hold assets that are less liquid, or in other words, more difficult to buy and sell.
Long time horizons
Investment trusts are an evergreen structure. Unlike open-ended funds, where a manager needs to sell portfolio holdings to return money to persons that have sold the trust, an investment trust portfolio remains intact. When sales of shares outweigh purchases, the value of the shares fall. With permanent capital to invest, many managers lengthen their investment horizons and choose to hold less liquid assets. Many trusts have been in existence for a century or more.
What type of assets can investment trusts invest in?
Investment trusts can invest in a wide variety of asset classes including stocks, bonds, property, private equity and other financial instruments. Owning shares in an investment trust is often an effective way of investing in some of the world’s most dynamic companies, markets and regions.
How does gearing work?
Just like other publicly listed companies, investment trusts can borrow money on behalf of their shareholders in order to invest in more assets.
It is often referred to as gearing because, just like gears on a bicycle, it multiplies effort. The central idea of gearing is that the additional investments made will make enough money to pay off the loan including interest and deliver a profit on top of that.
Income smoothing
Investment trusts can put cash away, or place into reserves, as much as 15 per cent of their revenues. This means a trust can add to these reserves when it receives high levels of dividends, and then use these reserves to add to the dividends paid to the trust’s shareholders in leaner years. Thereby smoothing the level of income.
Trading at a premium or discount
Investment trust shares are bought and sold on the stock market and are affected by supply and demand. If shares are trading at a discount, it means the price of a share is less than the trust's Net Asset Value (NAV) per share. When shares are trading at a premium, the price of a share is higher than the NAV per share.
What is Net Asset Value (NAV)?
Net Asset Value (NAV) is the value per share of the investment portfolio and other assets owned by the investment trust. It is calculated by deducting the total liabilities from the total assets and divided by the number of shares in issue at that moment in time.
Who's involved in an investment trust?
The role of the investment manager
It is the job of the investment managers, or ‘fund managers’, to manage the portfolio of investments and produce a return for shareholders. They work to a clear set of guidelines set out in the Investment Policy, which is available for all to see. The board of directors hold the investment managers to account on behalf of shareholders and should the need arise, could choose to change investment manager.
Independent board of directors
Investment trusts have an independent board of directors who are there to look after shareholders’ interests. It has various areas of responsibility, such as overseeing the performance of the investment managers, deciding on the dividend, and reporting to shareholders.
Owners as shareholders
As a shareholder, you have rights, including the right to vote on proposals put forward by the board, such as the level of dividend, change of investment policy or change of investment manager.
Brokers and auditors
Corporate Broker – An investment trust broker facilitates trading in the trust’s shares, advises on share buybacks and issuance, market strategies, and regulatory compliance to maximise shareholder value.
Auditor – An investment trust auditor ensures financial statements’ accuracy, compliance with regulations, assesses risks, and provide independent assurance on financial integrity.
What is the difference between an investment trust and unit trust?
While both investment trusts and unit trusts are types of pooled investment vehicles, there are some key differences between the two that can best be explained by first describing the features unique to an investment trust.
What's involved in owning investment trust shares?
How to buy and sell an investment trust?
Investment trusts are easy to access, and most persons and institutions can invest in them. Most savings platforms offer a range of trusts, they are also available via stockbrokers, ISAs, and savings schemes.
Liquidity
Investment trust shares are tradeable on the London Stock Exchange. Liquidity refers to how easily and quickly shares in trusts can be bought or sold. High liquidity means there are lots of buyers and sellers, allowing for smoother transactions. Liquidity is influenced by several factors including: marketability; amount of shares traded; bid-ask spreads; who holds the shares in that trust; market conditions and/or sentiment; and regulatory environment.
Can I use my ISA allowance to invest in an investment trust?
Yes. ISAs allow you to purchase and hold investment trusts in a tax efficient manner. The favourable tax treatment of ISAs is subject to individual circumstances and government legislation, as such, it is subject to change.
What are the associated fees and charges?
There are fees and charges associated with investing in investment trusts. These are trust specific and will vary depending on the type of assets held, and the manager you invest with. An additional factor to consider are the additional fees you may incur if you have sought independent financial advice.
Do investment trusts pay dividends?
Investment trusts are listed companies and therefore have the ability to pay dividends, however, not all do.
Is there a minimum or maximum investment?
Investment trusts generally have no minimum or maximum investment limits. However, minimum investments are typically determined by the cost of a single share, which can vary widely. Some trusts might have set minimum investment amounts, if bought directly through the fund provider. There is no maximum investment limit, but large investments might require additional considerations regarding market impact and regulatory compliance.
What are the risks of investment trusts?
A trust’s share price can rise and fall, independent of the underlying portfolio (or NAV) performance.
The income paid out in the form of dividends can rise and fall.
The use of gearing, or leverage, adds more risk. It amplifies the returns. If the portfolio performs well, the return is greater and if the portfolio is poor, losses will be made worse.
Each investment trust has its own investment objective. As such, the type and level of risks will vary depending on how it is managed and the underlying assets it holds.
Important information
Please remember that all investment strategies have the potential for profit and loss and your or your clients’ capital may be at risk.
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