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Back to basics: What is an investment trust?

Your Money
Written By:
Your Money
Posted:
Updated:
10/12/2014

We explain all you need to know about the world’s oldest form of collective investment vehicle.

What is an investment trust?

An investment trust is a company publicly listed on the London Stock Exchange that invests shareholder funds in the shares of other companies.

Trusts enable you to pool your money with other investors to invest in a range of assets to spread your risk so in principle should be less risky than buying individual shares.

They are closed-ended which means there are only a limited number of shares available, so for every buyer of an investment trust share there needs to be a seller.

This differs from open-ended funds or unit trusts, which are also collective vehicles, but which increase and decrease in size as investors enter and leave them.

Investment trusts are run by fund managers but also have an independent board of directors who are responsible for looking after shareholders’ interests.

When you buy an investment trust share, you are essentially buying a ‘share’ in all of the companies that the investment trust decides to invest in.

The dividend income you receive from the investment trust, and the value of its shares, will rise and fall in line with the performance of the shares which the investment trust owns and market forces.

What are the benefits of investment trusts?

Their closed-ended structure allows the manager to take long-term views and means they are not forced to sell in times of market volatility if investors want out.

They generally have lower annual management costs and tend to be better performers because they are not susceptible to inflows and outflows.

They are more transparent – they are required to list their full holdings once a year – and they have greater corporate government thanks to their board and chairman.

As they are companies, they can borrow money and invest the proceeds; this is known as gearing. The amount a fund can “gear” is the amount it can borrow in order to invest. This will increase returns to investors in a rising market, and vice versa in falling markets.

What are the disadvantages?

Gearing can work against the manager. If they borrow money to invest more in shares they expect to do well but they make the wrong call, their problems are intensified.

Liquidity can also sometimes be a problem as market makers attempt to match buyers to sellers.

How much do investment trusts cost?

Investment trusts charge an annual management charge (AMC) but it is usually lower than the AMC of an opened-ended fund or unit trust, typically 1% less.

However, as trusts are traded on the stock market, you will also have to pay a stockbroker to buy them on your behalf.

How are investment trusts priced?

The value of the assets held by an investment trust is called the net asset value (NAV), usually expressed as pence per share. So if a trust has £1m worth of assets and one million shares, the NAV is 100p.

The NAV can be influenced by supply and demand for the trust’s shares and at times these dynamics cause the price to fall below NAV or, at other times, rise above it.

This means the price you pay will almost invariably differ from the NAV.

If a trust is trading at less than its NAV, it is said to be trading at a discount. If the share price is higher than the NAV, it is trading at a premium.

Typically, investment trusts trade at a discount. This looks like good value, as you pay less than £100 for £100 worth of assets. However, there is no guarantee that any discount will have narrowed by the time you come to sell. If the discount widens then you’ll lose out in relative terms, whatever happens to the NAV of the trust.

Less often, trusts will trade at a premium to NAV. This means you’re paying more than £100 to own £100 worth of assets.

How are investment trusts regulated?

Investment trusts are regulated by the Financial Conduct Authority (FCA).

Are investment trusts ISA-eligible?

Yes.

What is the difference between an onshore investment trust and an offshore investment company?

They are both closed-end investments quoted on the London Stock Exchange but there are some differences in tax treatments: the Channel Islands based funds generally issue dividends gross; whereas UK trusts, as equities, issue dividends net.

How are dividend dates and rates calculated and by whom?

Dates are set, ideally, to provide a regular spread of income and are most likely on a quarterly basis.

The amount of dividend will depend on the underlying portfolio and the objective of the trust.