What Is An Investment Trust? (2024)

Investment trusts have a long pedigree, having been conceived in the 1800s as ‘closed ended’ investment vehicles with a fixed number of tradable shares.

However, they are less well known than ‘open ended’ vehicles such as unit trusts, where there is no limit on the number of units that can be created. According to AJ Bell, there’s ‘only’ £270 billion invested in investment trusts compared to £1.5 trillion in open-ended funds.

Investment trusts can offer many bene🐟fits to an investor looking to create a well-balanced and diversified portfolio. Some investment trusts have de💫livered dividend growth for 50 consecutive years, while others have consistently out-performed their open-ended fund counterparts.

Let’s take a look at what you should know about investment trusts, including how they operate, what they offer investors and how t𓆏o invest in them.

How do investment trusts work?

Investment trusts are a type of collective investment that pools money from investors to invest in a ✃portfolio of assets. Portfolios typically vary in size from 30 to several hundr✅ed different holdings across one or more sectors.

A fund manager is responsib🌜le for making the investment decisions to meet the trust’s investment objective which should cover:

• Type of return: growth, income or a mixture.
• Asset type: such as equities, fixed-interest securities or property.
• Geographical remit: including the UK, US, global or Asia Pacific.

How are investment trusts structured?

Investment trusts are ‘closed-ended’ with a fixed number of shares. Investment trusts are quoted on the London Stock Exchange, meaning that investors can buy and sell shares at li🐎ve prices, as with shares in a regular company.

Although the fund manager has a fixed pool of money from investors, they are also able to borrow money to invest alo𓆏ngside the initial capital invested, known as ‘gearing’. This enables fund managers to amplify t𝄹heir returns, although can also increase losses in falling markets.

Gearing is 🍨not allowed for most types of investment funds, partly as they can raise additional funds from investors if they are ‘open 🐼ended’.

How are investment trusts valued?

The net asset value (N🍰AV) of the investment trust is calculated as the value of all the underlying holding🧸s less any debt. The NAV is calculated on a per share basis, usually daily.

As with other types of shares, the share price of an investment trust is d🔯etermined by supply and demand. If investors believe tha🤪t the investment trust has strong growth prospects, higher demand should push up the share price.

Although investment trusts can trade at a premium or discount to their NAꦛV, they typically trade at a discount. In other words, the value of their underlying assets𒁃 is higher than their current share price.

While investment trusts trading at a discount may offer good value to investors, a discount may also be 🍸due to the low growth prospects or poor track record of the trust.

It’s a good idea to research the investment trust’s performance against its peer group 𒐪and benchmark before deciding whether to inves🅘t. Detailed information on investment trusts can be found on financial websites such as Trustnet and Morningstar.

What returns should investors expect?

Investment trusts offer investors the🌼 potential for two types of🅺 return:

Capital appreciation refers to the profit made if investors sell their shares at a higher ꦕprice than the purchase price.&nbsp🌟;

According to interactive investor, the AIC Global Investment Trust sector has🧸 returned an average of 440% over the last 20 years, compared to 329% for the fund-based IA Global sector.

One reason for this out-performance is the ability for fund managers to increase returns through gearing. Another facto⛄r is that the closed-ended structure allows managers to time the sale of their underlying holdings, rather than as a result of investors selling their stakes in the fund.

Income is paid by the majority of investment trusts in the forᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚm of cash d🍰ividends, quarterly, semi-annually or annually.

A key selling point of investment trusts is that, unlike funds, they’re able to retain 15% of annual income in a ‘rainy day’ reserve. This 🦩allows trusts to continue paying dividends when income falls due to challenging market conꦜditions.

The Association of Investment Companies (AIC) publishes a lis🅺t of ‘dividend heroes’ with a track record of consistently increasing dividends. There are 17 i✨nvestment trusts that have increased their dividends for the last 20 years, including 7 trusts with a 50-year track record of dividend increases.

According to the AIC, the average yield (dividend divided by the current share price) for inve🌺stment trusts for the UK Equity and Bond Income sector over the past year is 5.7%. This compares to an average dividend yield of 4.2% for the FTSE 100 in 2022, based on data from AJ Bell.

How can you buy investment trusts?

You can buy and sell investment trusts in the same way as ordinary shares, although it’s worth checking the best trading platform for your individual circ*mstances💃 as fees can♔ vary.

There are various type❀s of fees charged when holding investmꦉent trusts:

• Buy-sell spread: if the share has a buy-sell spread of, say, 96-98 pence, you will pay 98 pence to buy the share and receive 96 pence if you sell. Brokers make a profit on this margin, which can be up to 5% for less frequently-traded shares.
• Share trading fee: typically £5 to £10 when buying or selling investment trusts, although some platforms offer commission-free trading.
• Platform fee: some, but not all, platforms charge an annual fee for holding shares, which is typically a flat fee (of between £50 to £100) or a percentage fee (from 0.25% to 0.45%). This fee may be waived if you are a regular trader.
• Management fees: these are charged by the investment trust manager on an annual basis and are generally 0.5% to 1.5%, according to Morningstar. That said, over a third of investment trusts charge an annual fee of over 2% compared to just 8% of active funds.

What tax will I pay on investment trust holdings?

If you hold investment trusts outside a tax-efficient wrapper such as an Individual Savings Account (ISA) or Self Inves💯ted Personal Pension (SIPP), you will ℱbe liable to pay income tax on dividends received.

However, UK residents receive a of £2,000 (in the current tax year) which means that you won’t pa𝄹y income tax on dividends below this amount.

You will also be subject to capital gains tax if♌ you sell the shares for a higher price than you paid, subject to a of £12,300 (in the current tax year).

If you ♍hold the investment trust in an ISA or SIPP, you will not be required to pay income ꦿtax on dividends or capital gains tax on any profit.

What are the benefits and drawbacks?

These are advantages of investment trusts:

• Diversified portfolio: investment trusts provide investors with a ready-made portfolio, managed by professionals without the cost and time of investing in individual companies.
• Reliable income stream: many investment trusts offer a reliable and stable income stream, helped by being able to dip into reserves when needed.
• Access to a wider range of investments: unlike funds, investment trusts are not restricted to investing in listed securities which may increase returns.
• Visibility: investors can trade in investment trusts using ‘live prices’ unlike funds which are ‘forward’ priced. This also allows investors to use tools such as stop losses to limit their potential downside loss if the share price falls.

Investors should also be aware o🏅f the disadvantages of investm🐼ent trusts:

• Platform fees: most trading platforms charge a share trading fee for buying investment trusts, whereas trading fees for funds are typically lower, or zero. However, this may be offset by lower platform fees charged for investment trusts compared to funds.
• Annual management fees: according to Morningstar, the largest proportion of active funds charge an annual fee of between 0.5% to 1%, compared to over 2% for investment trusts. Annual fees can significantly erode the value of a portfolio over time.
• Valuation: unlike listed shares, alternative assets may not have a precise market value and may only be valued every quarter. This means that the net asset value may be less reliable as a basis for investment decisions.
• Gearing: while gearing can increase positive returns, it can also amplify losses in falling markets. As a result, investment trusts can be more volatile than their fund peers.

As with other investments, you should look to invest in investment♈ trusts for at least five to 10 years to smooth out any volatility from stock market downturns.