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Investment Trusts

An investment trust
Investment trusts are companies that invest in the shares of other companies.

They pool investors' money and employ a professional fund manager to invest in the shares of a wider range of companies than most people could practically invest in themselves. This way even people with small amounts of money can gain exposure to a diversified and professionally run portfolio of shares, spreading the risk of stockmarket investment. There are no specific investment restrictions for investment trusts, therefore some investments trusts are heavily invested in unquoted securities or the riskier emerging markets.

An investment trust has a fixed issued share capital, which means that the number of shares allowed in an investment trust is fixed - it is a close-ended fund.

The value of the shares in an investment trust is determined by stock market conditions, and the value may fall or rise and is not guaranteed.

There are over 300 investment trusts responsible for the management of billions of pounds' worth of assets on behalf of investors.

Investment trusts have several benefits for investors.

  • Allow you to pool your money. When you purchase shares in an investment trust you pool your money with all the other investors' money, providing potential economies of scale, in terms of dealing costs and administration.
  • Allow you to spread your risk. Each investment trust owns shares in a range of companies, so buying shares in only one investment trust effectively gives you a diversified portfolio. As you're not dependent on the success of just one or two companies, this spreads your risk.
  • Use professional managers' expertise. Each investment trust uses professional fund manager expertise.
  • May have low internal charges. Most investment trusts have low internal charges. Because the boards are independent of managers, they work to ensure that 'costs' or the funds' internal charges are not excessive and that the interests of shareholders are looked after. Low charges within the fund themselves mean more of your money is working for you right from the start of your investment.
  • Allow you to invest small amounts. You can invest small lump sum amounts or even invest monthly. Most trusts have savings schemes, some of which start from as little as 30 a month.

Put all these benefits together and you have an effective and cost-efficient way to invest in the stock market

Click on a heading for further information about these issues

What is a Closed-ended fund?

Investment trusts raise money for investing by issuing shares. Generally, this happens once - when the trust is created. This makes investment trusts closed-ended: the number of shares the trust issues, and therefore the amount of money it raises to invest, is fixed at the start. Knowing this amount of money is fixed enables fund managers to plan ahead.

Unit trusts and OEICs, on the other hand, are open-ended. They expand and contract all the time as people invest in or leave the fund.

Gearing

Investment trusts, being companies, can borrow to purchase additional investments. This is called "financial gearing". It allows investment trusts to take advantage of a long term view or favourable situation or a particularly attractive stock without having to sell existing investments.

The idea is to make enough of a return on the investment to be able to pay the interest on the loan, repay it and then make a profit on top of that. Obviously, the more a trust borrows ('gears up'), the higher the risk it's taking - but the greater the potential returns.

Financial gearing works by magnifying the investment trust's performance. If a trust "gears up" and then markets rise and the returns outstrip the costs of borrowing, the return to the investor will be even greater. But there is a downside to gearing too. If markets fall and performance of the assets in the portfolio is poor, then losses suffered by the investor will be increased due to the costs of borrowing.

Although the term gearing when applied to investment trusts usually describes the effect on the asset value, it also affects a trust's revenue and dividend potential.

When investment trusts gear up, they can usually borrow at much lower rates of interest than individuals or other kinds of companies. Investment trusts have great flexibility in the ways that they implement financial gearing, ranging from issuing long term debentures or preference stock or arranging bank loans at various interest rates set for the long or short term.

Not all investment trusts use financial gearing and many of those that do, use it to very modest levels. Whether or not to use gearing is a decision taken by the fund manager and the board of directors.

Other investment vehicles are unable to borrow to the same extent as investment trusts.

Buying at a discount

Buying at a discount of shares in an investment trust is established by the stock market. More often than not, investment trust shares tend to trade at a 'discount' i.e. when a share price is lower than the value of the underlying assets, expressed as the net asset value per share (NAV).

The prices of OEICs and unit trusts are calculated depending on the value of their assets, so you can never buy them at a discount.

Unlike other public companies investment trusts don't own factories or shops; they exist purely to invest in a portfolio of shares and securities in other companies to make money for their own shareholders. Many of them have existed for more than 50 years.

Specialisation in particular sectors

Trusts often specialise in particular sectors and types of company. Some specialise in companies from different parts of the world. Others choose particular kinds or combinations of businesses.

Some investment trusts are what's called a "fund of funds": their objective is to invest in other investment trusts, which means they take advantage of another layer of investing expertise (the fund managers in those investment trusts). This can give good results, but the disadvantage is that you may be exposed to additional layers of operating costs and gearing. They may also invest in trusts trading at a discount, when they think this represents a good buying opportunity.

Trusts also specialise in what they aim to return to their shareholders. Some try and maximise income. Others aim exclusively for capital growth over the long term. Some trusts aim to provide a combination of income and capital growth. All trusts have investment objectives that will be clearly stated in their literature.

If you would like advice about investing in Investment Trusts please contact us.