What is an Investment Trust?
An investment trust is a form of collective investment found mostly in the United Kingdom. This is a type of collective investment that allows investors to pool their money and make a profit by investing with other companies whilst retaining ownership and control of their individual shares.
Unlike unit trusts which are also called open-ended funds, an investment trust is more commonly used in the UK to include any closed-ended investment company’s with an independent board of directors and a limited number of shares available to buy from the existing shareholders.
The trade body that represents investment trusts is the Association of Investment Companies (AIC) who lists more than 30 different sectors grouped by the geographical area and type of investment with which they are involved.
How does it work?
Whereas most companies make and sell goods and services, investment trusts invest in companies which they expect to grow in value and generate revenue from the dividends it receives. You become a shareholder in that company when you invest in an investment trust. Your investment trust is managed by trust managers who are in charge of the day-to-day running of the trust, deciding when to buy and sell investments as best they can. Shares in an investment trust may trade for less than the value of the assets owned or for more than the assets owned at a premium.
Advantages
- Closed-ended – having a closed-ended structure, an investment trust has a fixed number of shares that allows trust managers to buy and sell assets when the time is right, not only when investors join or leave a fund making the underlying capital investment base relatively stable.
- Borrowing powers – investment trusts can also borrow money called gearing. Although debt adds a layer of risk, gearing takes advantage of investment opportunities depending whether the assets rise or falls in value.
- Competitive pricing – the charges are relatively lower with investment trusts as they have smaller operating costs compared with open-ended funds.
- Governance – all investment trusts have an independent board of directors that have a legal obligation to safeguard and protect the interests of every shareholder.
- Income – investment trusts can retain up to 15% of their income in any year which can help make their payments consistent with the extra income.
- Shareholder rights – by becoming a company shareholder, this gives you the right to vote on issues such as the appointment of directors.
Risks
In some ways, investment trusts can be an even riskier investment for the following reasons:
- Discounts vs. premiums – a discount is when shares trade below their NAV which means you are buying the trust below what the market thinks it’s worth. A premium is when the share price rises above the NAV which means that you are buying the trust above what the market thinks it’s worth. Investment trusts can trade at a premium or discount to the net asset value (NAV) since the share price depends on supply and demand.
- Gearing – borrowing money can magnify the trust’s performance but could also increase losses whether the assets rise or fall in value. It is important to remember to pay the interest on the borrowed money whether or not the trust makes a profit on the loan.
- Volatility – investment trusts can be a more risky investment since they are more volatile from the factors affecting their performance such as supply and demand.
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