Understanding investment trusts
Find out how investment trusts are able to combine diversification with low expense ratios.
What is an investment trust?
An investment trust is a form of a collective investment that invests in the shares of other companies, fixed income securities, property and many other assets. They are close–ended funds and are constituted as public listed companies meaning you can buy or sell shares in them as with any other listed company on the London Stock Exchange.
Like unit trusts and OEICs, your money is pooled together with that of other investors to invest large amounts and reduce costs. The manager of the investment trust makes the decision as to what assets are bought in order to build a diversified portfolio – they can be used as a simple and cost effective way to diversify your holdings. If you are looking for exposure to a particular country, region or industry, you can likely find an investment trust specialising in that area.
- As an investor buying shares in the investment trust company, you are effectively making an investment in all the assets held that the investment trust is invested in though of course it’s the investment trust company that actually owns them.
- Investment trusts are listed companies and therefore will have an independent Board of Directors. Their responsibility is looking after shareholders interests and they will decide who will manage the trust and set out the strategy and objectives of the investment trust.
- An investment trust can retain up to 15% of its income in any year which can be used to supplement dividends that it pays in future years.
- The Net Asset Value (NAV) is the total market value of all the investment trusts assets divided by the number of shares in issue. The NAV is typically published on a daily basis.
- Investment trust shares tend to trade at a discount or premium. A discount is where the share price of the investment trust is trading below the NAV (shares are cheaper than their net worth). A premium is where the share of the investment trust are trading above the NAV (the cost to purchase the shares is above what the underlying investment is worth).
- Investment trusts have the ability to borrow more money in addition to investor’s money to invest in more assets on behalf of their shareholders. This is known as gearing. This can help enhance returns in rising markets but it can also enhance the losses in falling ones, increasing the volatility of returns.
Investment trust vs unit trusts and OEICs.
There are two key differences between an investment trust and a unit trust.
Firstly, Unit trusts and OEICs
, meaning that when investors want to buy into a unit trust, the fund manager can issue new shares to accommodate the demand. However, investment trusts are close-ended. This means, a fixed number of shares are made available on the open market for investors to buy. If you come in as a buyer after the launch, then you can only do so if an investor wants to sell their shares. This means that the price of your investment trust shareholding is directly linked to supply and demand – the market value of the day. This is what moves the share price. If there are more buyers than sellers for the investment trust’s shares then that demand pushes up the price; if there are more sellers than buyers, that supply pushes the price down.
Secondly, in general, investment trusts offer a lower overall total expense ratio (TER) compared to unit trusts and OEICs. This might be because they are able to avoid the costs that go along with changing the size of the fund as investors buy in and out, since the fund size and number of shares is fixed.
Why choose investment trusts?
- Simple – they can be bought and sold just like shares, easy to trade
- Flexible – opportunity to invest in Global Markets and assets that can be difficult to access
- Diversification – investment trusts can be a useful addition to a balanced portfolio and allow you to spread your risk across different investments and asset classes
- Professional Management – investment decisions are made by experienced fund managers with access to specialist research and analysis
- Low cost – in general, investment trusts offer a lower overall Total Expense Ratio (TER) compared to Unit Trusts and OEICs. Full details can be found on the factsheet for each individual investment trust
- Choice - there is a wide selection to choose from with more than 500 listed on the London Stock Exchange across several different fund managers, giving access to many different asset types and global economies.
Things to consider
Investment trusts can have some drawbacks. While gearing can be seen as a positive, it can also multiply losses as well as gains meaning that they can be deemed a riskier investment to unit trusts.
In addition, the share price of an investment trust will vary depending on how many investors want to buy it. This means that the shares can trade at a premium or discount to the NAV, adding complexity to the pricing of investment trusts.
Investment trusts are a medium to long term investment, and therefore may not be suitable for everyone.
If you are unsure if investment trusts are right for you, you should seek independent financial advice. Remember that the value of investments can go down as well as up and you can lose money.
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