What are investment trusts?

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Written by: Tim Mitchell
03/10/2015
A back-to-basics look at investment trusts - what they are, how they operate and the pros and cons of investing in them.

Investment trusts are companies that pool investors’ money and use fund managers to invest in shares, bonds or other types of investment issued by other companies and by governments.

Investment trusts offer diversified, professionally managed exposure to the growth potential of global markets. As stock market listed companies, they have independent boards to represent the needs of investors, meaning you get the same level of protection as company shareholders.

Investment trusts issue a fixed number of shares, which are publicly traded on the London Stock Exchange. They can borrow money (gearing) to increase their market exposure and therefore potentially enhance returns. However, gearing can also increase the potential for losses when markets fall, so it is important to check how gearing is used in an individual trust.

The Net Asset Value (NAV) is the combined value of all the assets the trusts hold. Unlike other investment funds, shares in an investment trust can be bought and sold at a price higher or lower than NAV. So it’s possible to buy shares in an investment trust at a lower price than the value of the underlying assets.

It all comes down to market demand. If the share price is lower than the NAV the shares are said to be trading at a discount. However, when the share price is higher than the NAV, the shares are trading at a premium.

What are the main features of an investment trust? 

  • Closed-ended

An investment trust has a fixed number of shares. The fund manager can invest and sell assets when they feel the time is right; not when investors join or leave a fund. It also means the underlying capital investment base is relatively stable.

  • Borrowing powers

Investment trusts can borrow money (known as gearing) to take advantage of investment opportunities. Borrowing can increase the returns for shareholders, but if the assets fall in value, it can also increase the potential for losses.

  • Income

Investment trusts can retain up to 15% of their income in any year. This can be used to supplement income in future years.

  • Governance

Every investment trust has an independent board of directors. They’re responsible for safeguarding shareholder interests.

Shareholder rights

When you invest in an investment trust you become a shareholder in that company. This gives you the right to vote on issues such as the appointment of directors or changes to the investment policy.

Who should consider an investment trust? What part could it play in a portfolio?

Whether you are saving for retirement or looking for a way to supplement your income, investment trusts can help. They can be used as a complement to existing savings and investments, or several investment trusts can be combined to build the right investment portfolio to suit one’s individual investment needs.

Investment trusts have a lot to offer in the pension marketplace. As more pensioners look to their investment portfolios to provide income throughout their retirement, trusts have the ability to build dividend reserves and pay out both income and capital, so can play a crucial role.

What are the risks of investment trusts?

The risks associated with investment trusts are no greater than any other fund structure where the risk is determined by the underlying investments the fund holds, or the investment strategy. Additional risk (as defined by volatility) can be in relation to the use of gearing when losses can be magnified during a market downturn.

An investment trust’s discount can also widen or narrow which may also magnify potential gains or losses. This opportunity to potentially improve performance is part of the attraction of investment trusts and why many investment trusts existing today are some of the oldest investment funds available in the world today.

Are investment trusts FCA regulated?

Investment trusts are not regulated by the FCA, but their managers are.

All investment trusts have a board of non-executive directors and they play an important role looking after the interests of shareholders.

Tim Mitchell is head of investment trust sales at J.P. Morgan Asset Management

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