Investment trusts

A public limited company that aims to make money by investing in other companies

Investment trusts are public limited company entities listed and traded on the London Stock Exchange. These trusts are required to publish an audited annual report and accounts, and they also operate under a board of directors who oversee the trust’s manager. When you put your money into an investment trust, you essentially buy shares in that company.

Understanding gearing
Investment trusts and unit trusts differ significantly – the former can utilise borrowed capital, a concept called ‘gearing.’ This factor can significantly influence your investments’ value, for better or worse.

Gearing becomes a potent tool when stock markets are on an upward trajectory. It magnifies the profits you garner from your investments. However, the flip side is that gearing also amplifies your losses during market downturns.

A trust that employs high levels of gearing will inevitably take a steeper fall during unfavourable market conditions than trusts with low gearing. Essentially, the higher the borrowing within a trust, the more capital risk you are exposed to. Conversely, this also offers the potential for greater returns. The interplay between gearing and the discount means investment trusts will likely exhibit more volatility than their unit trust counterparts. As an investor in investment trusts, be prepared for a journey fraught with larger peaks and valleys.

It’s essential to note that not all investment trusts engage in gearing. The Association of Investment Companies (AIC) provides information about each trust’s gearing policy. A gearing rating of 100 signifies that the trust has zero borrowing. Conversely, a rating of 110 indicates that your profits or losses will be amplified by 10%. In simpler terms, the trust has a gearing of 10% of its total assets.

Investment trust prices
The value of the assets owned by an investment trust is termed the net asset value (NAV), typically expressed in pence per share. For instance, if a trust owns £1m worth of assets and has one million shares, the NAV is 100p.

When a trust’s trading price is less than its NAV, it is said to be trading at a discount. Conversely, if it’s higher than its NAV, it’s trading at a premium.

Investment trusts often trade at a discount, which can seem like a good deal since you’re paying less than £100 for £100 worth of assets. But there’s no guarantee that this discount will be lessened when you decide to sell. If the discount expands, you’ll lose out in relative terms, regardless of the trust’s NAV.

On rare occasions, trusts trade at a premium to NAV. This means you’re paying more than £100 to own £100 worth of assets. You might choose to do this due to the manager’s skill. However, it’s essential to consider whether this type of out performance will continue over time.

Traditional investment trusts
Investment trusts are structured as public limited companies, issuing a set number of shares, leading to their classification as closed-ended funds. These shares are traded on the stock exchange like any other public company. An investment trust’s share price is influenced by the value of its underlying assets and the demand for its shares.

Split capital investment trusts
Split capital investment trusts have a predetermined lifespan, typically spanning five to ten years. These trusts issue various types of shares, which, upon reaching their maturity date, offer payouts in accordance with the share type.

Choosing a share type that aligns with your risk tolerance and financial goals is crucial. Generally, shares situated further down the payment order exhibit higher risk but promise higher potential returns. Remember, share prices in an investment trust can fluctuate, meaning you may receive less than your initial investment.

Assessing asset types
The risk and return associated with an investment trust largely depend on the chosen trust. Understanding what assets the trust invests in is vital, as some carry more risk than others. Furthermore, evaluating the gap between the investment trust’s share price and asset value is crucial, as this disparity can impact your returns. A widening discount can potentially dampen returns.

Like unit trusts, investment trusts are classified based on the type of investment they focus on and the geographical area in which they operate. The Association of Investment Companies (AIC) oversees investment trusts and identifies over 30 distinct sectors. These include but are not limited to Growth in the UK, Global Expansion, Europe and Asia Pacific Infrastructure, Real Estate and Private Equity.

The fluctuation of discount or premium is often sector-dependent and is influenced by market sentiment. The risk level associated with a trust is primarily determined by its investment choices. Many leading investment firms have integrated socially responsible or ‘ethical’ investing into their investment strategies. They typically offer dedicated ‘ethical funds’ for investors to select.

These trusts invest solely in businesses that meet specific criteria, shunning those whose products or business practices fall short of the required standards. For instance, some ethical funds might exclude meat product manufacturers or companies that contribute significantly to greenhouse gas emissions.