Pros and cons of investing in Investment Trusts
If you’re still on the fence about whether Investment Trusts are right for you, we’re here to help. Check out our breakdown of the key pros and cons of investing in Investment Trusts.
Pros
One of the biggest advantages of Investment Trusts is that they're always actively managed, meaning they have a fund manager who's in charge of running the trust, making active decisions about the underlying investments, and making sure it's as successful as possible. Fund managers aren't untouchable, however, as Investment Trusts also have an independent board of directors to uphold the investors' interests at all times, as well as to ensure the trust is always abiding by compliance standards. If a fund manager underperforms or unduly jeopardises investors' funds, the board reserves the right to remove them. So there are checks and balances in place for that extra peace of mind.
Arguably the biggest pro of investing with an Investment Trust is their tendency to pay out bigger and more regular dividends than other types of fund. This is because Investment Trusts have the unique ability to set aside up to 15% of their income every year to stash away for when times get tough, so if there's a year when markets don't do so well and the underlying companies are struggling to pay their usual dividends, the trust can supplement this with the additional cash it's saved up to ensure investors still walk away with satisfactory income. It's why Investment Trusts are a good choice for investors who want to prioritise income over capital growth. There's even an elite group of trusts that have built a reputation for consistently paying great dividends, the Association of Investment Trusts' 'Dividend Heroes' - more on these here.
Another advantage of Investment Trusts is that they have the ability to trade at a discount from their Net Asset Value (NAV), which is just a fancy term for the innate value of all the underlying assets in the trust. Thanks to the fact that Investment Trusts have a closed-ended structure - meaning there is a limited number of shares available - the value of those shares can rise or fall depending on investor demand. For example, if the trust hasn't performed very well, it may trade at a discount from its NAV as investors look to sell their shares. Some may see this as an opportunity to invest and buy an Investment Trust while it's at a discount and then sell it again once the price moves closer to, or above, the NAV again - though, as is always the case with investing, this is never 100% guaranteed to happen.
Cons
Gearing describes the process when an Investment Trust's fund managers borrow money in order to purchase more investments. The idea behind gearing is that, if markets are on the rise, the trust can borrow money to get more exposure to stocks that it expects to perform well and magnify its gains. But it works the other way too. Gearing also increases the risk that, should the chosen stocks make a loss, the trust has nevertheless taken on a loan that it now needs to pay back - so its losses can also be magnified if markets fall. Not all Investment Trusts use gearing, and it's not wholly a disadvantage either. Gearing can be a very useful vehicle for fund managers to anticipate and take advantage of market movements, but if you're a little bit risk-averse, then the idea of a trust borrowing money to invest on your behalf might not sit so well with you. Read more about gearing in our Investment Trust glossary.
Just as we explained how Investment Trusts can trade at a discount to their NAV, they can also trade at a premium. This is usually due to a peak in investor demand for one reason or another, such as recent good performance or because its underlying assets are skewed towards a sector that is expected to do well in the near future. As demand for the trust grows, investors are able to raise the price at which they're willing to sell their share. Great news if you've got a trust already and you're open to selling, but perhaps not so good if you're trying to buy one yourself. Some Investment Trusts will intervene if their stock consistently trades at a premium for a long period of time by issuing new shares to meet the demand, but this is relatively unusual.
