What are Investment Trusts?
Investment trusts are savings vehicles with a twist. They are set up as companies – listed on the Financial Times Stock Exchange – and their shares are traded in the same way as any other company’s shares. The difference is that the sole purpose of an Investment Trust is to invest in other companies.
Investment Trusts have a great tradition, many have been in existence for over a hundred years, and they are an excellent way of generating consistent returns over long time periods.
An Investment Trust will own shares in a range of different companies, with the aim of creating a well-diversified portfolio that spreads its risk across a wide number of investments. Each trust appoints a professional manager to oversee the investments and ensure that the returns generated are in line with the aims and objectives set out for the trust at the outset.
Listed on the Stock MarketInvestment trusts are listed on the stock market, although they exist only as a portfolio of investments. However, each trust has a Board of Directors, which has a duty to look after the interests of its shareholders, and make sure that the trust is being maintained and managed properly.
Shareholders also have the same rights as with any other company, and they can vote on issues at the trust’s Annual General Meeting. They can even vote to request a change in the members of the Board, or the Trust manager, if they feel that they are not happy with the way the trust is run.
The Close-End StructureWhen an Investment Trust is created it raises money by issuing a limited number of shares to potential investors. This gives the Trust a set amount of money that it can invest in, and makes it a ‘close-ended’ investment (unlike unit trusts and OEICS, which are open-ended).
The 'Net Asset Value'A close-ended structure means that the number of shares available is fixed and no more shares can be created. This means that if the Trust makes a profit, the value of each share rises, and if it loses money, the net asset value (NAV) of each share falls. Shares can then be traded at a ‘premium’ (a price that is higher than their NAV value) or at a lower price (known as a ‘discount’).
The ability to purchase shares at a discount to their NAV is a significant selling point for Investment Trusts, and a major difference between trusts and other types of investment. The prices of unit trusts and OEICS are calculated depending on the value of their assets on any given day. This means that you will not be able to purchase units at a discount.
There are several reasons why a trust would trade at a discount. If investor sentiment is poor, or the trust invests in areas of the market that are not popular (investing in financial companies as an example), or perhaps poor past performance. You could find a bargain if you think that the discount to NAV does not reflect the fair value of the Trust, and that there is the potential for greater returns in the future.
GearingBecause they are run as companies, Investment Trusts can borrow money and use the additional funds to purchase additional investments. This is known as ‘gearing’, and it allows companies to generate greater returns. Gearing can be very successful when stock markets are rising, because the manager can make a profit far higher than the cost of the borrowing needed to fund the investment. However, if markets are falling the risk of making a loss is magnified, as the investment will have lost money and the loan will still need to be repaid.
Not all Investment Trusts use gearing, and those that do are usually bound by the stated aims and objectives of the Trust, to ensure that any gearing is kept within manageable levels.