Investment Trusts: Busting the jargon in 10 simple steps
3 Mar, 2022
I’m new to Boring Money, and while I know my way around ISAs and LISAs and even JISAs, I’m not exactly a whizz when it comes to understanding the more niche investment products out there.
If you’re anything like me, you may have seen - and were completed baffled by - the term ‘Investment Trust’, which gets thrown around from time to time when talking about investing. Although there are plenty of city-slickers out there that explain what an Investment Trust is, they tend to use confusing technical jargon that gets people like you and me no closer to working it out than when we started.
So, I’ve done a bit of digging and put together 10 simple steps to understanding what an Investment Trust is - staying light on the jargon so you don’t end up with a headache.
The what, why and how of Investment Trusts
An Investment Trust is a product in which 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, but typically follow a theme, such as: large American companies, emerging market bonds, or even 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 Investment Trust at any time if a situation calls for it. For example, if a particular firm in your American company-themed Investment Trust tanked, the fund manager could remove it from the Trust to limit the damage it would do to your profit.
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 very 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 Investment 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 that 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.
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. Say the 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 a premium. Similarly, if the Trust is falling in demand, sellers can reduce the value of their share from £10 to £8, so that the Trust is trading at a discount.
“Gearing” is also a unique characteristic of Investment Trusts, which is when a fund manager borrows money and reinvests this debt into the Trust itself. 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.
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: the fund manager can set aside up to 15% of the Trust’s income during successful years to boost dividends at times when it hasn’t performed so well. Because of this, Investment Trusts tend to consistently pay - and even increase - their dividends during periods of market turmoil.
Plus, Investment Trusts often work out a fair bit cheaper compared to other actively managed funds. New data from FundCalibre found that the average fee for an active fund was 0.95% as of February 2022, whereas the average fee for an Investment Trust is around 0.65%. What’s not to like?
The 3 most popular Investment Trusts in the UK are Scottish Mortgage, Smithson Investment Trust, and Edinburgh Worldwide (as of January 2022), according to data from interactive investor.
So there you have it – Investment Trusts in 10 steps. If you’re looking to iron out more of the details, check out our full guide to Investment Trusts, where you can get into the nitty-gritty as well as a round-up of the best-selling Investment Trusts of recent months.
