Investment trusts are a type of collective fund, where investors pool their capital together for management by a professional Fund Manager, who uses their skill and experience to select a range of investments to meet a clear set of objectives. Those objectives are clearly defined for each Investment Trust, and could include income, growth, or a combination of the two. They may focus on a specific sector, region or asset type.
Where investment trusts differ from other collective funds is that they are structured as a company. This means they have a board, which - in common with a normal company - is there to act in the best interests of shareholders. It also means they are listed on an exchange, such as the London Stock Exchange. Investors buy and sell shares in an investment trust, in the same way as they would buy or sell shares in a company.
Investment trusts can borrow money to make additional investments. This is known as ‘gearing’. It lets the manager of the trust buy shares without having to sell existing investments. In practice, many trusts will use moderate gearing where they see strong market opportunities. They need to be clear that they can generate a higher return on their investments than the cost of borrowing. The risk of using gearing is that it can magnify losses at times of market stress.
Investment trusts are ‘closed-ended’. Other collective funds such as unit trusts and OEICs (Open-Ended Investment Companies) are ‘open-ended’. In these cases, the investment manager has to buy new investments as new money comes into the fund, or sell investments as money is withdrawn. In contrast, investment trusts have a fixed pool of assets. The managers don’t have to deal with inflows and outflows of money from the trust. The price of the trust is determined by demand for the shares, like it is for a normal company.
The share price of a trust may not necessarily reflect the exact value of the underlying assets (also known as ‘net asset value’ or NAV), but may trade at a premium or discount. Where investors are optimistic that the value of the underlying assets will grow, a trust may trade at a premium. If the investors are worried about the prospects for a particular trust or sector, a trust may trade at a discount.
The closed-ended structure with its pool of assets affords investment trust managers more flexibility.
It can offer significant advantages for the day-to-day management of an investment portfolio. Because the manager does not have to deal with subscriptions or redemptions, they can focus solely on the investment merits of each opportunity. This gives them the freedom to be more agile and opportunistic - buying when areas are out of favour and selling when they start to look over-valued. Ultimately, it supports a longer-term, more disciplined investment approach. That said, in giving the fund manager greater flexibility, it means that trust performance is more dependent on their skill and judgment, which can be positive or negative.
By contrast, managers of open-ended funds are often influenced by the popularity or otherwise of a particular area. When a sector is in fashion and money comes in, they may be forced to buy at rising prices. Similarly, during periods of weakness, they may have to sell holdings to meet redemptions, even if the operational performance of individual companies remain attractive. This can make it harder to take a long-term view and can lead to buying high and selling low.
Discounts can also create opportunities for investors to buy a portfolio of assets at less than the value of the underlying assets. If a particular area has been out of favour, investors may buy a trust with the hope of both the revival in the share price and the share price discount to net asset value narrowing. Of course, this can also work in reverse: if a trust is trading at a premium and it falls out of favour, losses may be exaggerated as both the NAV falls, and the discount to the underlying value of the assets grows wider.
A dedicated board is another key advantage for investment trusts. It appoints and oversees the investment manager, holding them to account and may consider replacing them if objectives aren’t being met. The board also monitors fees to ensure competitiveness and may pursue corporate actions to enhance shareholder value. These might include share buybacks, where management teams reduce the number of shares in issue, with the aim of improving the share price.
Investment trusts have certain advantages for income investors. As income comes in from the underlying investments - dividends from shares, or interest from bonds, for example - the investment trust structure allows them to reserve up to 15% of this income and set it aside for periods where income is scarce.
Many trusts have built up significant reserves,[1] which enables them to continue to maintain a dividend, even if the underlying assets are no longer paring an income. This helps to provide some reassurance to investors that there is likely to be a consistent income in periods of economic weakness, when companies may reduce their payouts. This was seen during the Covid pandemic, when many companies cut or cancelled their dividends. In many cases, investment trusts were able to maintain their income levels to shareholders because of their reserves[2].
Also, many trusts have a long-term track record of paying growing dividends to their investors[3]. Some trusts have an explicit target to grow the income they distribute to investors and a long track record of doing so.
Investment trusts have stood the test of time. The first trust was launched in 1868, with the aim of bringing new opportunities to “investors of moderate means”. They are fulfilling this objective almost 160 years later, a tribute to their strength and adaptability. Investors have used them to deliver their income and capital growth objectives over many decades.
It is straightforward to invest in a trust, with most investors buying and selling through investment platforms. You will receive an instant offer price and your capital is invested immediately. If you need to sell, the same is true. You receive an instant selling price, which you can choose to accept or not.
There can be differences in the way you pay for investment trusts versus an open-ended fund. Open-ended funds may charge an upfront fee, and then an ongoing management fee. Investment trusts don’t have upfront fees, but may have dealing costs. A dealing cost is a fee paid to a broker or platform, each time you buy or sell an investment. They will also charge an ongoing management fee.
Investment trusts are another form of collective fund, with many of them providing diversified, managed exposure to global stock markets. Nevertheless, their structure brings some differences with open-ended funds. They have proved their worth in investor portfolios over many years and have helped grow investors’ capital and income through a range of market environments.
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