Investment trusts

Investment trusts issue a fixed number of shares for investors to buy. This approach raises a fixed amount of money for the manager to invest in a portfolio of assets.

Just like listed companies, you can buy and sell shares in investment trusts on the stock market. The share price goes up and down according to investor demand and supply. But unlike OEICs, the trust manager's investment plans are not affected by these fluctuations.

There are various types of investment trust, but the majority invest in shares.

Some investment trusts invest for a set objective, such as capital growth, income, or a mix of both. Other trusts invest in certain sectors or regions. The main regions offering investment trusts are UK, US, Europe, Asia Pacific and emerging markets. A number of trusts simply adopt a global approach, in which the fund manager invests wherever they see fit.

Another type of investment trust, which has been gaining in prominence, is those that focus on alternative assets. Some popular sectors include renewable energy, infrastructure, commercial property and private equity. 

There are other investment trusts available, such as:

• Venture capital trusts (VCTs) that invest in small unlisted companies. These trusts come with certain extra tax breaks.
• Real estate investment trusts (REITs) that invest in commercial property.
• Split capital trusts that issue a number of different classes of shares.

Investment trust managers can borrow money to invest more in the trust. This tactic is called gearing. Gearing in a rising market magnifies gains for each shareholder. But if the market falls, investors in a geared trust will suffer greater losses per share. Gearing can improve performance, but it also means investment trusts tend to be higher risk than some other types of funds. 



Here’s an example of gearing:



Let’s say you have £1,000 invested, and the manager gears by 10%; this equates to £1,100 working for you in the investment trust. If the share price doubles, the value working for you rises to £2,200. The manager must pay back the £100 they borrowed plus, let's say, 1% interest. But that still leaves you with £2,099. If the manager had not geared, you'd only have £2,000.



Imagine now that the same investment halves in value to £550; the manager still has to pay back that £101. This magnifies the losses, leaving you with only £449 instead of the £500 you'd have without gearing.

Advantages of investment trusts:

• Over the long term, investment trusts tend to outperform funds due to their various structural advantages.  
• Trusts are much more consistent at raising or maintaining dividend payments compared to funds. This is due to their ability to hold back up to 15% of income generated every year. 
• Benefit from a fixed pool of assets. This means the fund manager isn’t distracted by investor money flowing in or out in the short term.
• Trusts offer an opportunity to buy a bargain when a trust trades on a wider-than-usual discount. 
• Investment trusts are allowed to borrow money, or ‘gear’, to invest. In a rising market, gearing magnifies gains.  
• Trusts are overseen by an independent board of directors, who ensure the investment trust is being managed in line with shareholders’ interests. 

Disadvantages of investment trusts:

• Generally, trusts are more volatile than open-ended funds due to the ability to gear and the potential for discounts to widen beyond NAV movements, so expect a bumpier ride. 
• In a falling market gearing works in reverse, so investors in a geared trust will suffer greater losses per share.
• Investment trusts can trade on a premium, so investors who buy can end up paying more than the underlying assets are worth. 
• Trusts are often considered more complex to understand than other types of investment.
• It can be difficult to find information about less commercially focused trusts.

Diversified global investment trusts with a broad range of underlying investments can form an ideal portfolio core and are perfect for regular monthly investments. Many global and UK trusts are also ideal for income-seekers because of their ability to smooth dividend payouts over the years. 



Also, investment trusts that adopt a ‘multi-manager’ approach should be considered. This means the portfolio is parcelled up, with different segments of the portfolio outsourced to carefully selected external fund managers. One respected trust that invests in this way is F&C Investment Trust, which is one of our Super 60 fund choices.  

Many investment trusts are set up to pay dividends to their investors. Other investment trusts focus on capital growth only, so don’t pay dividends.

In fact, income-paying investment trusts can be particularly attractive to investors. Up to 15% of the income generated by the trust’s underlying assets can be held back each year. This means the trust can build up a ‘rainy day’ fund to bolster dividend payouts in leaner years. During the financial crisis, most UK equity income investment trusts could either maintain or increase their dividends as they dipped into their reserves. 



Some income-paying investment trusts are labelled ‘enhanced income’ and generally offer higher dividend yields than other income trusts. To achieve a higher dividend yield, enhanced income trusts finance their dividends from capital as well as income. 

Investment trusts have two important values:

• Total value of the underlying assets (called the net asset value or NAV, given as a price per share)
• The share price

Understanding the significance of these values can help you decide whether to buy shares in an investment trust.

When the share price is lower than the NAV, the investment trust is said to be trading at a ‘discount’. In other words, investors are paying less for the trust than its assets are actually worth. When the share price rises above the NAV, the trust is trading at a 'premium'. This status means that investors who buy into the trust are paying more than the underlying assets are worth.

Since the share price depends on supply and demand, investment trusts can trade at a premium or discount to NAV. Investors can benefit from buying at a discount, providing the discount gets smaller. It can, of course, work against investors if the discount goes the other way and increases, which will magnify losses.

Learn more about investment trust premiums and discounts