What is an Investment Trust?
What is an Investment Trust?
An Investment Trust is a product where you (and a bunch of other investors) pool your money together for a fund manager to invest in things – such as shares, bonds, property, and so on – with the aim of making a profit if those assets gain value. They come in all shapes and sizes, and can invest in all sorts, from large American companies to emerging market bonds to property in up-and-coming neighbourhoods.
Investment Trusts are typically actively managed, meaning that the fund manager responsible for deciding what your money goes into can adjust the underlying shares in the trust at any time if a situation calls for it. For example, if shares in a particular company in your Investment Trust fell, the fund manager could remove it from the trust to limit the damage it would do to your profit.
You can read our in-depth guide to Investment Trusts here for more on their pros, cons, charges and the small print you need to know.
How do Investment Trusts work?
Investment Trusts are traded on the stock market throughout the day in the same way as shares are. So, you can buy or sell them at short notice just as you would with the individual assets that they’re made up of – but see the step below to find out why they won’t always trade instantaneously.
What makes Investment Trusts unique is that they’re closed-ended, which is the technical term for saying that each trust is split into a fixed number of shares available to purchase when it's first launched. Unlike traditional funds where the fund manager can generate more shares as and when needed, Investment Trusts are capped at the initial number, meaning you may not be able to buy one if all the shares are already taken. You would have to wait until someone who owns a share decides to sell. This is rarely an issue with the more popular trusts, but if you're looking at something more niche, you may find that trade is a bit slower.
What are premiums and discounts?
Another quirk unique to Investment Trusts is that their value can be more or less than the constituent parts they’re made of, depending on the balance between supply and demand. For example's sake, let's say an Investment Trust is made up of 100 shares which are worth £10 each. If the trust comes into high demand, those selling their share may hike up the value from £10 to £12, so that the trust is trading at what's called a "premium". Similarly, if the trust is falling in demand, sellers can reduce the value of their share from £10 to £8, so that it's trading at a "discount".
What is gearing?
“Gearing” is also a unique feature of Investment Trusts, and is the term given to when a trust borrows money. This is usually to acquire more assets - for example, if a particular share becomes desirable and the fund manager wants to incorporate it into the trust without having to sell existing assets to raise enough money. The aim is that the extra investment earns the trust enough money to pay off the loan and any interest attached to it. So in theory, gearing can help to magnify a trust's profit - if it works. Of course, there's always the risk that it could work in reverse.
Not all Investment Trusts use gearing though, and it will be well-signposted if they do. If in doubt, search for the trust on the Association of Investment Trust's (AIC) website and click on the "gearing" tab to find out if, and to what extent, the trust is geared. The AIC also has a handy 1-minute video explaining everything you need to know about gearing and the risks and benefits that come with it. Check it out below!
Video provided courtesy of the AIC.
What are dividends?
One of the major perks of Investment Trusts is that they offer dividends, which you can think of as a cash bonus you get to say “thank you” for investing in them. But here’s the icing on the cake: a fund manager can set aside up to 15% of a trust’s income during successful years to boost dividends at times when it hasn’t performed so well. Thanks to this unique function, Investment Trusts tend to consistently pay - and even increase - their dividends during periods of market turmoil, and are an attractive option for investors looking for a steady stream of income, particularly if they focus on trusts with a reputation for consistent dividend payments.
If that's what you're looking for then the AIC's Dividend Heroes are the optimal place to start. These are an elite group of Investment Trusts recognised by the AIC for increasing their dividends for a minimum of 20 consecutive years - through the 2008 financial crash and the Covid-19 pandemic no less. At the time of writing there are 20 Dividend Heroes, while a further 30 have been identified as the "next generation", with over 10 years' of consistent dividend increases under their belts. Most of the trusts on these lists are perennially-popular, but if you aren't familiar with them yet, they make a sensible choice for investors seeking a steady source of income.
How much do Investment Trusts cost?
Investment Trusts often work out a bit cheaper compared to other actively managed funds, but it depends on how you go about purchasing one. The average annual fee for other types of active fund is 0.95%, whereas the average annual fee for an Investment Trust is typically around 0.65%. More on that below.
Some trusts allow you to purchase shares directly from them, meaning you won't have to pay any middlemen to carry out your transactions for you, but this option means you're usually quite restricted in your choices.
Alternatively, you can use an online investment platform to buy an Investment Trust, which usually costs more but gives you access to many more trusts - pretty much all of them on the market, around 350. And, of course, you can opt to get a stockbroker to buy a trust for you - though this method isn't as popular these days, as this can be expensive and not nearly as simple as doing everything online.
The cost of investing with an Investment Trust can usually be broken down into the following subcharges:
Management fee: This is the fee you pay to the fund manager for managing the trust on your behalf, and can range from as little as 0.25% to well over 2% a year.
Performance fee: Some (though not all) trusts charge a performance fee, which you only pay when the trust outperforms specified benchmarks - often set out in the factsheet. You won't have to pay it if the trust doesn't exceed this threshold.
Annual charge: The yearly charge you pay to invest in the trust itself. This differs significantly from trust to trust, but typically ranges from 0.5% to 1%. Alternatively, some Investment Trusts use a flat rate rather than a percentage.
