Investment Trusts

Investment trusts are companies which issue shares to raise money and invest the capital in other companies to generate returns.

Essentially, they are just like any other company listed on the stock market – but instead of being a single company's share, their single purpose is making money by investing for their shareholders. And their assets are simply the shares the manager buys in other companies.

Just like units trusts or Oeics (open-ended investment companies), investment trusts are a type of collective fund run by an expert manager who chooses a wide range of sectors and assets to invest in. 

But investment trusts are different; they are closed-ended funds which can only issue a fixed number of shares. This is in contrast to unit trusts or Oeics (open-ended investment companies), which issue and cancel units depending on investor demand. Being closed ended can make investment trusts more volatile than open ended funds.

Investment trusts have often been favoured by private client stockbrokers but are not as well-known among ordinary investors. This is partly because most financial advisors tend to recommend unit trusts and Oeics, which are easier to explain and earn them commission.

Nonetheless, investment trusts have several advantages. Notably, they can often prove cheaper than their unit trust counterparts.  Their total expense ratios (TERs) are often below 1% while TERs on unit trusts often exceed 1.7%.

And unlike unit trusts or Oeics, thanks to their closed-end structure investment trust managers are not forced to use extra money to buy shares at top prices, or sell holdings simply because investors want out. This means they can take a more long-term view, because they are not being forced to sell in periods of market volatility.

But there are other important points to consider. Firstly, when you buy investment trusts you will pay stamp duty at 0.5% just as you do on most other shares – and you’ll also pay stockbroking commission.

Then there are the technical details on investment trusts which go some way to explaining why they’ve never caught on so much with private investors. The most important of these is the Net Asset Value (NAV).

If you look at the prices of investment trust shares in a newspaper, you’ll see that there is one column for Discount to Net Asset Value. Usually, investment trust shares trade at a discount – although occasionally they do go to a premium to NAV.

The NAV is basically the total value of the trust's portfolio of investments divided by the total number of its own shares.

Some say these discounts make investment trusts slightly more risky, since the value of a holding is influenced by the amount that the discount to NAV changes during the term of investment. If it gets smaller, you will make a bit more money – or lose less. If it widens, the effect will be reversed. But if you hold an investment trust in the long-term, any movement in the discount should (hopefully) be dwarfed by the performance of its assets over the long term.

Another feature of investment trusts is "gearing", which means borrowing to buy extra shares that the manager believes will perform well. If the manager gets it right, this can lead to higher returns and these will be higher than those achieved by unit trusts, which are not allowed to borrow to buy shares. But if they get it wrong and the shares fall, investors face more problems.

It is important to do your research and understand what you are investing for.  There are hundreds of investment trusts available, all offering different levels of risk, from those concentrating on single countries to the well-established, large general trusts which can produce performance figures going back many years. One of the largest, the Foreign & Colonial, was founded in 1868 making it the oldest collective investment fund in the UK.

To help you choose, investment trusts tend to be listed on the Association of Investment Companies (AIC) website, showing their past performance as well as their yields and discounts or premiums.

Some of the larger investment trusts such as the Foreign & Colonial and Alliance Trust offer cheap monthly savings schemes, which allow you to buy the shares regularly and hold them within an Isa or self-invested personal pension (Sipp). 

You can go to an independent financial adviser for more guidance on what to invest in. If you choose to invest directly, you can use an online stockbroker to buy the shares just like those of any company or buy through a fund supermarket or wrap. Unlike buying a unit trust, you won't have to pay an initial charge of up to 5% of your cash, though you will have to absorb the 'spread' – the difference between the buying and selling price of the share.