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Investment trusts explained

One of the oldest types of investment fund around, investment trusts offer some unique benefits.

Overview

What is an investment trust?

An investment trust is a type of investment fund. It is structured as a public limited company – or PLC. Its shares can be bought and sold on the stock exchange, just like other public limited companies. Investment trusts have been around since the 1860s, making them one of the oldest types of investment fund around.

Investment trusts look to make returns for their shareholders by managing a portfolio of investments. Every investment trust has a formal investment objective which details which markets or sectors they invest in. The objective will also indicate if the trust aims to deliver capital growth, income or a mix of both.

Features

What are the features of investment trusts?
As a public limited company (PLC), investment trusts offer some important features:
Tradable shares – You can invest in an investment trust by buying its shares and becoming a ‘shareholder’. This entitles you to vote on issues affecting the company and to receive any dividend that the company chooses to pay out. The value of your investments can fall and rise, the same as a share price does.
Dividends – Like other PLCs, investment trusts may pay their shareholders an annual ‘dividend’ out of the profits they make from their investments. Dividends are not guaranteed and can rise and fall from year to year. Investment trusts can smooth out their income payments by holding back profits in good years to pay out in poorer years.
Board – Each investment trust has a board of directors and a chair to oversee the operation of the company and that it is managed in the best interests of shareholders. The board has the power to set charges and costs on the trust and appoint (or fire) an asset manager to manage the portfolio.
Discounts & premiums – A trust’s share price is driven by investor demand in the marketplace. So it can be higher (at a premium) or low (at a discount) than the value of its underlying assets. This is a big difference from other types of funds such as unit trusts and OEICs, whose price directly mirrors their underlying portfolio.
Gearing – Investment trusts can borrow money to invest, as well as using their share capital. This can help generate additional returns for investors – but it can also potentially increase losses and make the value of the portfolio more volatile. So it’s important to check the level of gearing is right for you.
AGMs and annual reports – Investment trusts keep their shareholders informed about their performance through half-yearly and annual reports and by holding an annual general meeting (AGM). At the AGM, shareholders can hear from the board and investment manager and vote on issues. They can also propose motions in advance to be voted on.

Benefits

What are the benefits of investment trusts?
Like other types of investment fund, investment trusts offer important benefits such as:
  • A team of professionals to choose investments on your behalf
  • A ready-made portfolio holding a range of different investments which can help spread risk
  • A clear investment objective – so you can choose which trust is right for you
  • A price that can (usually) be tracked daily so you can follow your performance
But as listed companies, investment trusts also offer additional advantages:

Independent board

The board oversees shareholders’ interests, including ensuring the investment manager is delivering on the agreed objectives and that charges are competitive.

Shareholder rights

As with all public companies, shareholders can attend annual general meetings and propose and vote on issues.

Daily liquidity

Shares can be bought and sold daily even if they hold ‘illiquid’ investments like property or shares in private companies

Income reserves

Trusts can hold back some of their investment income year to year to help smooth out future ‘dividend’ payments.

Gearing

Trusts can borrow money to invest if they wish. This can boost potential returns – but can also increase magnify losses.

Intra-day trading & pricing

Investment trust shares trade (and their price changes) throughout the day – not once a day like other funds.

Investment advantages

These unique features allow investment trusts to play some important roles in a portfolio:
To hold ‘illiquid’ and specialist assets – Investment trusts can hold investments that can’t be liquidated easily while still allowing their own shares to be bought and sold daily. This makes them popular for investing in property, private equity and other specialist asset classes. (Investors need to accept that the market price of their shares could be ‘at a discount’ to the value of the underlying assets.)
To aim for steady income – Because they can hold back profits from year to year, investment trusts can aim to deliver a steady and rising income, even in challenging markets. The AIC details investment trusts that have increased their dividend for 20 years or more.
To achieve active management at low cost – Larger ‘generalist’ trusts investing in the UK or globally use their economies of scale and efficient corporate structure to have highly competitive management fees.

Risks to be aware of

The value of investments and the income from them - Can go down as well as up and you may get back less than the amount invested.
Share price volatility – Because the price of investment trust shares is driven by market demand (not just the performance of the underlying investment portfolio) they can be more volatile than other types of fund.
Discounts – If market demand for shares is low, an investment trust’s shares may trade below the value of its net asset value. Trading ‘at a discount’ means your shares don’t reflect the full value of their underlying investments.
Gearing risk – Holding a high level of borrowing can increase potential losses if markets fall in value. Highly-geared trusts can see more volatility in their share price.

Want to learn more?

If you would like to know more about investment trusts and how they work, visit the AIC website.*

*This is an external site. abrdn is not responsible for its content.

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