Investment trusts: A beginner’s guide

What are they?

Investment trusts are closed-ended vehicles, meaning they have a fixed number of shares in issue. This contrasts with unit trusts and OEICs, which are open-ended, meaning the number of units or shares in issue varies according to demand.

With a unit trust, an investor is effectively buying the underlying shares that the fund manager invests in. With an investment trust, which is a company in its own right, the investor is buying shares in the company, which in turn invests in the shares of other companies. This means that the value of a share in an investment trust varies according to both demand for its shares and the performance of the assets it is invested in.

Discounts and premiums

If an investor owns shares in an investment trust and then demand for these subsequently increases, for example if a high-profile manager takes over, the investor’s shares will increase in value.

If the price of an investment trust is higher than its net asset value (NAV – the total value of the assets it is invested in), this is known as trading at a premium. If the price is lower than its NAV, this is known as trading at a discount. 

Discounts can present buying opportunities to investors, especially if with a trust that is out of favour but has good prospects. However, there is also the chance that a discount on a trust can widen after the investor has purchased shares.

Pros and cons

In July, FE Trustnet published research highlighting how a number of high-profile closed-ended vehicles, including Standard Life UK Smaller Companies investment trust, tended to outperform unit trusts that they are supposed to be mirroring. Harry Nimmo, who manages both vehicles, said the ability to gear up, or borrow money, was one of the reasons for this outperformance. 

Investment trusts can employ this technique to a greater extent than unit trusts, which are limited to 10 per cent of the value of the fund. However, although this gives the managers the freedom to increase their weighting to a stock they have a high conviction in, this also has the potential to amplify losses in a down market.

Closed-ended vehicles also tend to be cheaper than unit trusts. “TERs tend to be between 0.4 and 0.8 per cent,” said Ewan Lovett-Turner, analyst at Numis Securities.

Stephen Peters, analyst at Charles Stanley, said: “These low fees make them especially suitable for very long-term investors.”

Lovett-Turner continued: “Other benefits of investment trusts are that they can build up revenue reserves so that when earnings fall, they can still pay out a dividend. Even during 2008 to 2009, many of the larger trusts managed to grow their dividends.”

“Also, the lack of investor flow means there is no pressure to sell in falling markets.”

Peters added: “There are more asset classes available to investment trusts, including private equity, debt and infrastructure.”

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