For first-time investors in trusts, here is an overview of investment trusts – what they are and how they invest – from editor JONATHAN DAVIS.
What is an investment trust?
Investment trusts, also known as investment companies, are a type of collective investment fund. All types of fund pool the money of a large number of different investors and delegate the investment of their pooled
assets, typically to a professional fund manager. The idea is that this enables shareholders in the trust to spread their risks and benefit from the professional skills and economies of scale available to an investment management firm.
Collective funds have been a simple and popular way for individual investors to invest their savings for many years, and investment trusts have shared in that success. Today more than £180bn of savers’ assets are invested in investment trusts. The first investment trust was launched as long ago as 1868, so they have a long history. Sales of open-ended funds (unit trusts and OEICs) have grown faster, but investment trust performance has generally been superior.
How do investment trusts differ from unit trusts and open-ended funds?
There are several differences. The most important ones are that shares in investment companies are traded on a stock exchange and are overseen by an independent board of directors, like any other listed company. Shareholders have the right to vote at annual general meetings (AGMs) and vote on the re- election of the directors. Trusts can also, unlike open-ended funds, borrow money in order to enhance returns. Whereas the size of a unit trust rises and
falls from day to day, the capital base of an investment trust remains fixed.
What are discounts?
Because shares in investment trusts are traded on a stock exchange, the share price will fluctuate from day to day in response to supply and demand. Sometimes the shares will change hands for less than the net asset value (NAV) of the company. At other times they will change hands for more than the NAV. The difference between the share price and the NAV is calculated as a percentage of the NAV and is called a discount if the share price is below the NAV and a premium if it is above the NAV.
What is gearing?
In investment gearing refers to the ability of an investor to borrow money in an attempt to enhance the returns that flow from his or her investment decisions. If investments rise more rapidly than the cost of the borrowing, this has the effect of producing higher returns. The reverse is also true. Investment trusts typically borrow around 10–20% of their assets, although this figure varies widely from one trust to another.
What are the main advantages of investing in an investment trust?
Because the capital is largely fixed, the managers of an investment trust can buy and sell the trust’s investments when they wish to – instead of having to buy and sell simply because money is flowing in or out of the fund, as unit trust managers are required to do. The ability to gear, or use borrowed money, can also potentially produce better returns. The fact that the board of an investment trust is accountable to the shareholders can also be an advantage.
Another advantage is that investment companies can invest in a much wider range of investments than other types of fund. In fact, they can invest in almost anything. Although many of the largest trusts invest in listed stocks and bonds, more specialist sectors, such as renewable energy projects, debt securities, aircraft leasing and infrastructure projects such as schools, have also become much more popular in recent years. Investment trusts offer fund investors a broader choice, in other words.
And what are the disadvantages?
The two main disadvantages are share price volatility and potential loss of liquidity. Because investment trusts can trade at a discount to the value of their assets, an investor who sells at the wrong moment may not receive the full asset value for his shares at that point. The day-to-day value of the investment can also fluctuate more than an equivalent open-ended fund. In the case of more specialist trusts, it may not always be possible to buy or sell shares in a trust at a good price because of a lack of liquidity in the market. Investors need to make sure they understand these features before investing.
How many trusts are there?
According to the industry trade body, the Association of Investment Companies, there are currently around 400 investment trusts with more than £180bn in assets (as at the end of September 2018). They are split between a number of different sectors. The largest trust has approximately £5bn in assets.
How are they regulated?
All investment companies are regulated by the Financial Conduct Authority. So too are the managers the board appoints to manage the trust’s investments. Investment trusts are also subject to the Listing Rules of the stock exchange on which they are listed. The board of directors is accountable to shareholders and regulators for the performance of the trust and the appointment of the manager.
How do I invest in an investment trust?
There are a number of different ways. You can buy them directly through a stockbroker, or via an online platform. Some larger investment trusts also have monthly savings schemes where you can transfer a fixed sum every month to the company, which then invests it into its shares on your behalf. If you have a financial adviser, or a portfolio manager, they can arrange the investment for you.
What do investment trusts cost?
As with any share, investors in investment trusts will need to pay brokerage commission when buying or selling shares in an investment trust, and also stamp duty on purchases. The managers appointed by the trust’s directors to make its investments charge an annual management fee which is paid automatically, together with dealing and administration costs, out of the trust’s assets. These management fees typically range from as little as 0.3% to 2.0% or more of the trust’s assets.
What are tax wrappers?
Tax wrappers are schemes which allow individual investors, if they comply with the rules set by the government, to avoid tax on part or all of their investments. The two most important tax wrappers are the Individual Savings Account (or ISA) and the Self-Invested Personal Pension (SIPP). The majority of investment trusts can be held in an ISA or SIPP. There are annual limits on the amounts that can be invested each year (currently £20,000 for an ISA). Venture capital trusts (VCTs) are a specialist type of investment trust which also have a number of tax advantages, reflecting their higher risk.
Where can I find more information?
The best place to start is with the website of the Association of Investment Companies (AIC), which has a lot of basic information, as well as performance and other data. The Money Makers website has detailed tables summarising the main features of the most important trusts. Most online broker platforms, such as Hargreaves Lansdown, Fidelity Funds Network and The Share Centre provide factsheets, performance data, charts and other information. Most trusts now have their own websites too.
Independent research sites, such as FE Trustnet, Interactive Investor, Citywire, DigitalLook, Morningstar and periodicals such as the Financial Times, MoneyWeek, Money Observer and Investors Chronicle also regularly provide updates and recommendations on investment trusts. Citywire has a dedicated online investment trust newsletter. Investment Trusts is an independent subscription-only newsletter.