What is an Investment Trust?
An investment trust is a company that invests in the shares of other companies. They provide exposure to a pool of underlying assets, and are cheaper to buy than their unit trust counterparts. Pooled funds allow investors to gain a wider exposure to shares, and at a much lower cost, than they could by investing directly. Investors also benefit from having a full-time manager choosing their investments, often backed by internal research teams, which should help to improve the performance of the trust.
Just as with any company, investment trusts have their own board of directors which oversees the management of the trust, and it is their responsibility to make sure that the trust is meeting its targets as set out in its portfolio. Investment trusts are governed by stockmarket rules because they are companies listed on stock exchanges and they are also governed by company law. There are over 300 investment trusts according to the Association of Investment Companies(www.theaic.co.uk), responsible for over £65 billion of investors' money.
Investment trusts are not the only type of pooled fund. There are also unit trusts and open-ended investment companies (Oeics) which offer the equivalent wider exposure to stocks and shares. But there are some significant differences that investment trusts have compared to other pooled offerings.
Closed-Ended Funds
Investment trusts are closed-end funds, meaning that the number of shares being issued by the trust is fixed when the trust is created, so the trust managers know exactly how much money they will have to invest. Unit trusts do not have this fixed limit, and they change in size depending on how many investors enter or leave the fund.
Gearing
Investment trusts are able to borrow money to invest in the markets, in order to help enhance returns, a process known as 'gearing'. This can be a mixed blessing. By being able to borrow to invest, the fund manager can boost returns, but if things go wrong, it will amplify losses too.
As the trust is taking effectively taking out a loan to increase investment in the market, the hope is that markets will rise to outstrip the cost of the borrowing. The impact is most keenly felt on the asset value of the trust, but it will also affect the ability for trusts to pay dividends as it can affect the revenue stream.
Discounts & Premiums
Investment trusts companies trade at a discount or a premium because with a limited number of shares available to investors, demand can increase or decrease depending on the trust’s success. So if you purchase shares at a discount, you are paying less for the shares than the value of the underlying assets. This is expressed as the net asset value (NAV) per share. As unit trusts and oeics have their prices calculated directly on the value of their assets, there is no possibility of buying these at a discount.
Split Capital Investment Trusts
Some investment trusts issue different types of shares to appeal to various investors. These are known as split capital investment trusts. Splits – as they are known – will usually have three types of shares - ordinary, income and zero dividend preference shares. Ordinary shares aim to provide capital growth, but no income. Income shares will provide an income stream but no capital growth. Zero-dividend preference shares will not provide either specifically, but aim to pay out a fixed amount at a set date in the future.
A few years ago splits were the subject of scandal when thousands of investors lost millions of pounds after stockmarkets fell, and the cross-investing between split capital trusts and high gearing that many had taken on caused more than 20 to collapse. It was the first time that zeros had failed to pay out, and compensation for the victims of the splits debacle is still being sorted out. However, the number of trusts affected was relatively small, and splits are still offering investment options to investors.
Charges
Because buying shares in an investment trust is the same as buying shares in any other company, you will be charged stamp duty on the transaction at 0.5 per cent.