What is an Investment Trust?
Investment trusts are a type of investment fund that has been around for over 150 years. Like funds such as open ended investment companies (OEICs) and unit trusts, investment trusts provide a ready-made portfolio of investments managed by an expert investment team.
How investment trusts work
The term ‘investment trust’ is rather misleading – it’s a public limited company (PLC), not a trust. As with any other company, investors buy shares. The money raised is invested by the trust and if the underlying investments do well the share price of the investment trust rises.
Investment trusts are companies that invest in other companies. They follow a wide variety of investment policies, usually specialising in a type of investment or particular geographic region. Similar to the shares of public companies, investment trust shares are traded on stock exchanges on a daily basis.
The share price of an investment trust is determined by the degree of supply and demand that exists for its shares. It follows therefore that the price of an investment trust’s shares does not always fully reflect the underlying value of the trust’s portfolio.
If the price is below the net asset value the trust is said to be trading either at a ‘discount’. If the price is above its net asset value then it is said to be at a “premium” . Net asset value being the market value of all its investments and assets less its liabilities.
Discounts and premiums can therefore compound the effect of rising and falling markets on an investment trust price.
GearingWatch the video
Investment trusts have the ability to borrow additional money to invest, known as gearing. This can enhance potential investment returns but gearing can also increase the investment risk of a trust, so whilst gearing can boost gains, it can also magnify losses.
Almost all investment trusts have the ability to use bank loans, bank overdrafts and derivative instruments such as Contracts for Difference (CFDs) to increase their exposure to stocks. CFDs are used as a way of gaining exposure to the price movements of shares without buying the underlying shares directly.
Investment trusts: don’t be put off by the complexity …
As quirky as they are, we love investment trusts. If you take a look at the performance tables, you’ll see that over the long term, the average investment trust has consistently outperformed the average unit trust and OEIC. That’s particularly significant when you consider that the performance of individual investment trusts varies so much. In other words, if the average of all investment trusts — good, bad and indifferent — outperforms the average of all unit trusts, then consider what an investment in one of the better investment trusts might do!
Of course, it’s important to remember that you need to take several factors into account when choosing an investment trust, not just price discounts and premiums. In addition to the risk that the market as a whole will rise or fall, you need to consider how the trust’s portfolio will perform against the market, what the current discount or premium is and where it might be heading, whether the manager can successfully manage the fund to provide positive returns in the future and what extra volatility or risk will be created by the trust’s gearing.
Find an investment trust specialist…
As with other investments, the value can fall as well as rise and you may get back less than you invested. Before you invest in investment trusts ensure you consult an adviser with the capability and knowledge to apply to your investment portfolio to ensure you get investments that are the suitable for you.