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The IC guide to Investment Trusts

Get to know investment trusts with the help of our handy guide
The IC guide to Investment Trusts

Key Points:

  • Investment trusts are listed on the stock market just like any company, but pool investors’ money like a fund
  • There are more than 300 investment trusts to choose from on the UK stock market
  • They are a great way for new and experienced investors to ensure their portfolios are appropriately diversified

What is an investment trust?

Investment trusts are a type of collective fund listed on the UK stock market. Like other funds, they take investors’ money and pool it together to buy assets. Many investment trusts invest in equities, but increasing numbers of them are focused on more unusual assets such as private equity, infrastructure, debt, property and hedge funds. 

Why should I invest in an investment trust?

Investment Trusts are a great way to diversify if you are starting out as an investor, and even if you have built up a large portfolio. There are investment trusts for every type of market and sector – from the UK to China and from unlisted companies and small caps to industry and global giants. They can be used to create a solid foundation for your portfolio or to gain exposure to niche and specialist areas such as emerging markets easily and quickly. You can leave all the research and monitoring of the underlying stocks to the trust manager.

Still not sure about Investment Trusts? Here's our resident expert John Baron to explain why "investment trusts are a superior option"

Convinced - How do I invest?

Investment trusts are listed on the stock market just like any company. You buy and sell shares in trusts just as you would buy and sell shares in any listed company. The easiest way to do this is through an investment platform. You can hold investment trusts in a general investment account, Isa or Sipp, so how much you pay will depend on which platform and which plan you use.

In this free guide, we walk you through the buying and selling of investment trust shares and show you which platform might suit you best. 

Which investment trust?

What you invest in will be influenced by what you already hold or by gaps in your portfolio. For example if you have a number of tracker funds giving you exposure to UK and global markets, then you might be looking for an investment trust that invests in emerging markets. Or you might be seeking the expertise of an active manager who will select individual holdings in a particular market rather than simply tracking an index for the whole market. You might believe that one sector is important and likely to perform well and so you would look at specialist trusts that would give you exposure to a particular sector – such as technology or healthcare, or even a single country. 

 

How do investment trusts compare to other types of pooled funds?  

Although unit trusts, open-ended funds, ETFs and investment trusts largely perform the same role in that they pool money to buy individual holdings on behalf of all the investors, they all do the job in slightly different ways. Some differences might mean extra risk, but also extra reward. Here are four of the main ways that funds and investment trusts are different:

1. Structure

Investment trusts are closed-ended, which means that a limited number of shares are issued. This creates a stable situation for the manager who does not have to worry about lots of investors wanting to pull their money out in a hurry (in an open-ended fund, investors can request to withdraw their money at any time). They won’t be forced to sell holdings to meet investor redemptions and can hold assets for the long-term. This is helpful with, for example, commercial property which can take a long time to sell. 

2. Gearing

Investment trusts can take on debt (gearing) to invest more than the money they have taken from investors. This can boost an investment trust’s returns when the value of what it holds, for example equities, is rising because it has greater exposure. 

But when the value of its holdings are falling having extra invested can compound losses. So, for example, if an equity investment trust has substantial gearing when markets are falling it could make particularly bad returns. Another downside to gearing is the cost of the debt, as if this is expensive it will detract from the trust’s and ultimately its shareholders’ returns.

3. Discounts and premiums

Because investment trusts are listed on markets they have a share price. But their share price does not necessarily reflect the value of their assets so they can trade at a discount or premium to their net asset value (NAV). This can be beneficial to investors in that they can get opportunities to buy investment trusts for less than the value of the assets they hold. 

But it can be detrimental to returns if the share price falls and the discount widens after you have bought the trust. Investment trust discount and premium movements can also be volatile which arguably makes investment trusts higher risk than similar open-ended funds. 

4. How dividends are funded

Unlike unit trusts and open-ended funds, investment trusts can retain up to 15 per cent of their income in any year in a revenue reserve. This means that in years when the income a trust receives from its holdings is not enough to pay the same level of dividend that it paid the year before, or increase it, it can still do this by drawing from its revenue reserve. 

Some investment trusts, meanwhile, can enhance their income by taking it from capital – selling assets to pay dividends. This means that trusts which invest in areas that do not generate much income, such as private equity, can still pay attractive dividends. The downside to this is that selling assets effectively reduces the potential for growth. And this is a detrimental strategy in falling markets because it accelerates a decrease in the size of the trust’s assets, reducing both its potential for growth and income. 

Only a few investment trusts pay dividends from capital and you can see whether this is the case on their websites and or their annual reports. 

Tech trusts for maximum growth

Allianz vs Polar Capital

Investment trusts specialising in the US tech space have enjoyed considerable success in recent years. Can it continue? This article compares the fortunes of two of the most popular investment trusts available to UK investors; Allianz and Polar Capital Technology Trusts.

Hear from the managers of Allianz and Polar Capital in the podcasts below

Scottish Mortgage Technology Trust

Has the success of Scottish Mortgage inspired the growing number investment trusts which are dipping their toes into unquoted stocks? And is it the right strategy? This article examines the positives and negatives of the UK's most popuar investment trust. 

 

Your questions, answered

Do you have questions about investing in investment trusts? Chances are, someone has asked the question before. The articles in the links below can help you learn from other people's portfolio management. Or submit your own portfolio and have it analysed by Chris Dillow, Investors Chronicle economist, and other selected top industry experts.

How do I diversify away from the UK and Europe?

James (43) earns £84,500 a year and his wife earns nearly £100,000 a year. Their home is worth about £600,000 and has an outstanding mortgage of £60,000. They want to gain better returns to improve their retirement pot. Click here to read how investment trusts can help. 

Should our focus remain on funds rather than direct equities?

Jeff and Claire are 43 and 41, and have three children aged four, seven and nine. Between them they earn £130,000 a year before tax, which covers all their bills. They want to know what the best type of holdings are for their portfolio. Click here to read our experts' advice.