In the dark about this type of investment? We explain what they are and how they work
Investment trusts have been around for 150 years, but they still divide opinion among investors.
While those in favour point to an impressive track record of delivering returns, others argue they’re not always the cheapest fund options and can be volatile.
However, most agree they possess unique qualities that make them worth considering by anyone investing over the longer term.
What are investment trusts?
They are companies that are listed and traded on the London Stock Market in the same way as normal shares.
In fact, they are also commonly referred to as ‘investment companies’, because their business is investing assets on behalf of their shareholders.
Run by dedicated managers, investors’ cash is pooled and put to work across a wide range of areas, including other companies and alternative asset classes.
Their ability to get access to more specialist areas of the market, borrow money to invest and smooth out returns sets them apart from other investment products.
According to Patrick Connolly, a chartered financial planner at Chase de Vere, their structure means they are easy to understand.
“Every investment trust has an independent board of directors, which is responsible for looking after shareholders’ interests,” he says. “It will, for example, ensure the trust is run according to its investment remit and that the correct governance procedures are in place, as well as setting dividends to be paid to shareholders.”
The directors on these boards meet several times a year and monitor the trust’s performance. If it is not up to scratch, they can replace the fund manager.
How do they work?
Investment trusts are known as ‘closed-ended’ because there will only ever be a set number of shares available to buy – irrespective of demand. Unlike open-ended funds, they cannot automatically create and cancel units in response to the amounts being invested.
This means the demand for a trust will influence its share price.
When a lot of investors want shares, the ‘share price’ will exceed the valuation of the underlying assets. This is known as trading at a premium.
Conversely, when demand is low the share price will fall below the valuation of the underlying assets. At this point, the trust will be trading at a discount.
For Adrian Lowcock, head of personal investing at Willis Owen, this can be a blessing or a curse.
“You run the risk of overpaying, but there’s also the opportunity of buying them cheaply,” he says.
He argues that trusts in popular, trendy sectors can get expensive.
“They’re potentially more volatile than the market and can fall further than their underlying investments during big sell-offs,” he explains.
What do trusts invest in?
They can put their money into a wide variety of areas and their ‘closed-ended’ structure enables them to invest in more specialist areas. These include less liquid asset classes, such as private equity, commercial property and infrastructure, that are not easily accessible to other fund types.
This liquidity issue is important. For example, if someone wants their money back from an investment trust, they can simply sell the shares. If they are in an open-ended fund, such as a unit trust, the manager may have to sell some of the underlying holdings to redeem units. In areas such as commercial property, this can take some time.
Not having to worry about dealing with lots of redemptions in troubled times enables managers of trusts to take a longer-term view on potential investments.
Other qualities
An interesting feature of trusts is the fact they can use gearing, points out Mr Connolly at Chase de Vere.
“They can borrow extra money to invest, and this gives an added boost to returns if the underlying investments perform well,” he explains. “This is why investment trusts usually outperform similar open-ended investment funds over the long term.”
However, gearing isn’t a guaranteed route to success.
“If the underlying investments perform badly, then investors will have more money exposed to this bad performance and must pay interest on the money borrowed,” he adds.
Another benefit is that trusts can hold back up to 15% of the dividends from the underlying portfolio, says Mr Lowcock. “This helps them smooth the income paid out as they can use these reserves to ensure the dividend is maintained and grows even in poorer years,” he explains. “A consistent income is essential for long-term investors.”
Popularity of investment trusts
Investment trusts have been around a long time. The first was the F&C Investment Trust that launched back in 1868 – and it’s still going strong today. It now boasts nearly £4 billion of assets under management and invests in more than 500 companies across 35 countries.
Today, there are more than 400 trusts across sectors as diverse as emerging markets and Japanese smaller companies to infrastructure, financials and environmental.
They are also increasingly available on investment platforms, says Martin Bamford, managing director of financial planners Informed Choice.
“Since commission on investment products was abolished at the end of 2012, investment trusts, which don’t typically pay fees to advisers, have operated on a more level playing field with unit trusts and open-ended investment companies,” he says.
The whole investment trust area is thriving now, agrees Annabel Brodie-Smith, communications director for the Association of Investment Companies (AIC).
“Assets under management were close to an all-time high of £184 billion at the end of January 2019,” she says.
Who are they suitable for?
An investment trust is worth considering by anyone wanting to invest over the longer term – at least five to 10 years.
The sheer number of trusts available, each with their own aims and objectives, means there is a good chance of finding at least one to meet your needs. For example, younger investors seeking to maximise growth may be drawn to a trust that focuses its attention on the emerging markets, which are riskier economies with higher growth potential.
Others may want exposure to specialist areas, such as commercial property, as a part of their broader portfolio, while those approaching or in retirement may need a reliable trust that can deliver income.
Mr Bamford suggests investment trusts tend to favour the long-term investor, who is looking for exposure to a specific sector or theme.
“They often appeal to more experienced investors who take an active interest in the management of the trust and its approach,” he says. “Investors should be comfortable with the closed-ended pricing features and any use of gearing within the trust.
“Like all investments, a trust can fall in value, so investors need to have sufficient capacity for losses before making an investment.”
If you need advice choosing investments, you should seek the help of an independent financial adviser.
How have they performed?
As with all types of investment, there have been winners and losers. Success depends on a variety of factors, including the skill of the management team at the helm and whether the area in which it invests is in favour.
A look at the performance figures over the past decade illustrates the point with the best performers enjoying double-digit annualised returns – and the worst losing money.
Lindsell Train, which aims to maximise long-term total returns with a minimum objective to maintain the real purchasing power of Sterling capital, has been one of the standout names. If you had invested £100 in this trust 10 years ago, you would now have £1,118.02, according to AIC/Morningstar data to the end of February 2019.
However, trusts at the other end of the performance table tell a different story. A £100 investment at the same time into Golden Prospect Precious Metal, which is in the Commodities and Natural Resources sector, would now be worth -£26.72.
How much do they cost?
People can buy shares directly from an investment trust company or from a DIY investment platform or stock broker.
Costs will be a vital part of the decision-making process. In its simplest form, the higher the charges levied, the better your investment needs to perform to make you money.
The costs you might incur will depend on how you buy your investment trusts. For example, if you opt to go via a platform or stock broker the charges for their services will vary. If you hold shares through an individual savings account (Isa) wrapper, there may be fees attached.
Costs have changed in recent years and this is a consideration for investors, points out Justin Modray, founder of Candid Financial Advice.
“Investment trusts used to benefit from generally lower charges than unit trusts, but with the abolition of sales commissions, prompting cheaper unit trust versions, they are broadly similar these days,” he says. “In fact, unit trusts are typically cheaper if anything.”
Although many trusts provide a low-cost route to active management, this isn’t always the case.
“Some of the more specialist equity trusts can be relatively expensive, usually because the impact of fixed running costs are exacerbated on relatively small funds,” adds Mr Modray.
“We only recommend active managers over lower-cost trackers when we believe they have the ability and strategy to outperform, after charges.”
Making your choice
Deciding which is suitable for you will depend on your aims and objectives, as well as your attitude to risk.
“Investors should look at the history of the investment trust to understand its performance and trading history, including whether current levels of discounts or premiums are typical or unusual,” says Mr Bamford.
Ms Brodie-Smith believes there is something for everyone. “We have everything from traditional global investment trusts to more exotic asset classes,” she says. “You just need to make sure you’re happy with the investment risk being taken.”
As part of our First 50 Funds for beginners, Moneywise has selected 10 investment trusts that investors could consider buying and stashing away for the long term (see table below).
Investment trusts in Moneywise First 50 Funds for beginners (ranked by yield)
| Name | Discount/premium %* | Gearing %* | Ongoing charges figure %* | Yield % | Five-year return % |
|---|---|---|---|---|---|
| F&C Commercial Property (FCPT) | -11.1 | 26 | 1.22 | 4.9 | 28.9 |
| The City of London Investment Trust (CTY) | 1.7 | 12 | 0.41 | 4.5 | 30.9 |
| Murray International Trust (MYI) | 4.7 | 12 | 0.64 | 4.4 | 47.7 |
| Picton Property Income* (PCTN) | -4.11 | 37 | 1.2 | 3.74 | 94.19 |
| Henderson Smaller Companies Investment Trust (HSL) | -7.5 | 11 | 0.98 | 2.6 | 54 |
| Witan Investment Trust (WTAN) | -2.8 | 15 | 0.86 | 2.5 | 70.1 |
| Finsbury Growth & Income Trust (FGT) | 0.2 | 0 | 0.67 | 1.9 | 72.1 |
| Jupiter European Opportunities (JEO) | -5.1 | 6 | 2.5 | 0.9 | 64.2 |
| BMOGlobal Smaller Companies | -1.9 | 6 | 0.6 | 1.2 | 58 |
| Scottish Mortgage Investment Trust (SMT) | 2.2 | 8 | 0.37 | 0.6 | 145.2 |
Note: Discount /premium, and all other data sourced from the AIC/Morningstar, 7 March 2019 * Picton Property Income data, FE Trustnet, 14 March 2019
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