Investment trusts explained
Updated
August 28, 2024
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And why they might be right for you.
Don’t you just love a good investment trust? No? Well that might be because they don’t really get out in the sunlight that often.
They’re a bit like that spice in the rack you swear you’ve seen people use but can’t quite figure out when to use it yourself.
Individual shares, exchange-traded funds (ETFs) and open-ended investment companies (OEICs) tend to hog the limelight while trusts just carry on in the background.
But I have a real soft spot for them. I just wish more people knew the ins and outs of what they offer, their advantages and their drawbacks.
At least then we can all see whether investment trusts are a worthy addition to the portfolio or not.
So, let’s find out. Here are the sections we’ll be covering:
Picture a supermarket trolley full of stocks with a professional shopper pushing it round the aisles, deciding which companies to buy and which ones to put back on the shelves.
And because they’re a professional, you pay them to do it for you, and so do a lot of other people. That’s the basis of it all.
So how can you get access to that person’s skills, their strategy and that particular blend of stocks in their trolley?
Well, you can find the trolley itself on the stock market with its own price that changes throughout the day.
In essence, the trust looks like a mutual fund (or OEIC) and quacks like a fund but it’s traded like a share.
And there’s a very good reason for that - it’s actually a company in its own right. You might even see them being referred to as investment companies.
That’s the language the Association of Investment Companies (AIC) likes to use because it can make it clear that this is a listed company that invests in a range of other companies.
So, to recap - an investment trust (or investment company) is a collection of shares chosen by a manager, and listed on the stock exchange for you to buy and sell.
Diversification is a big plus.
You get instant access to a collection of shares with the aim of spreading risk and having at least some cylinders firing at any one time.
It’s true that more focused trusts won’t give you diversification by sector or geography. Trusts like Polar Capital Global Healthcare or Fidelity Asian Values have specific confines to where they want to invest.
But, if you’re looking for diversified exposure to a certain strategy or sector and want someone with experience to pick what they think are the winners in that sector, trusts can help.
And while we’re on it - having other humans involved in your investment journey seems to provoke a fiery rage among investors these days but it doesn’t have to.
Having a team of analysts behind the decisions being made for the portfolio can really help - as long as the management team delivers good value for money.
And it’s that last part that none of us should compromise on.
Measuring a fund’s ability to meet its own objectives and provide you with good returns over and above a relevant index fund or ETF is important. (Otherwise why not just invest in the passive option?)
As always, past performance is no guide to what might happen in the future but what I’m talking about here is the investment process as well.
Does the person in charge have a proven ability of knowing what to do in times of opportunity or volatility? Can they do it better than you? Does their general approach to investing sit well with you? And are they worth what they’re charging?
Another human element that trusts offer, and that isn’t available in a lot of other fund structures, is a board of directors.
They’re there to hold the manager to account for their investment decisions and all-round running of the trust.
If they aren’t impressed they have the power to give the manager the heave-ho and hand it over to someone else. It’s always good to know your managers have managers.
Before there were lightbulbs or trouser zippers, there were investment trusts. It’s true.
The first of its kind, the F&C investment trust launched in 1868, aiming to bring ‘stock market investing to those of moderate means’. And there are quite a few slightly younger siblings still around too.
In this world - long term means long term.
And, because investment trusts have a fixed number of shares in issue, once they raise money initially, the manager gets on with investing it.
Any buying and selling of the trust’s shares happens on the market and doesn’t affect the money inside the trust.
The manager doesn’t have to worry about keeping some money aside in case there’s a big demand for withdrawals, like they would in an OEIC.
This lets them adopt a super-long term view around the companies they invest in, without that nagging feeling that they might need to sell to meet sudden redemptions.
That’s especially useful if the manager is buying into unloved companies that might take a while to turn themselves around or restructure and resurrect the share price.
When you don’t know how long that will take, sometimes your money has to be patient. Here are three trusts doing just that.
The penultimate pro I’ll mention is around what a trust manager can do when they want to really capitalise on a high conviction idea.
In this instance, the trust can borrow cash to allow the manager to put even more money into a set of assets. This process is known as gearing.
That additional money can amplify returns if the investment does what the manager wants it to do but it can lead to higher losses if the investment fails to pay off. This is why you’ll also see gearing in the ‘negatives’ section further down the page too.
And lastly, it’s worth highlighting that trusts don’t just have to invest in companies listed on the stock market. Many take advantage of being able to invest in private and early stage companies.
Why? It’s because of that long-term focus again. Trusts can afford to be patient with fledgling firms or those getting themselves ready to list on the market because they don’t have to worry about suddenly having to sell to meet redemptions.
That means trusts can be one of the only ways everyday investors can access the growth potential of private companies.
Trusts like RIT Capital Partners make use of this functionality. It currently holds around 25% of its assets in private equity, including hedge funds and private firms.
The key here is that investors can access this world, maybe to add diversity to our own public equity holdings, in a way that is heavily diversified itself and not reliant on us selecting these types of assets ourselves.
Read more:
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Five dividend-paying stocks on Freetrade
One specific thing I think worth highlighting is a trust’s ability to lay aside 15% of its income in bumper years and use it to bolster payments to investors when dividends are hard to come by.
2020 is a prime example of the dangers income investors face, with dividends being axed all over the show and UK banks being told to stop payments at once.
If you’re relying on those payments to fund your retirement income or provide a passive income to supplement your salary, having the taps turned off can be incredibly damaging.
But throughout the madness of 176 UK firms stopping dividends altogether in the second quarter of 2020, with a further 30 companies reducing payments, just two of the 182 UK investment trusts focused on equities cut payouts.
There are even dividend-obsessed trusts on a mission to constantly grow their income payments. All hail the Dividend Heroes.
You can read more about them here.
We’ve talked about the potential positives of having a human in charge. But that brings all the biases and emotions that humankind just can’t get rid of.
You don’t have control over what the manager is buying and if you have a very specific idea of where you want your money to go and when, a trust might feel too restrictive.
Then there’s the issue of cost. Trusts are often more expensive than ETFs because all of the analysis in the background, meeting with company management, board members and internal trading costs mounting up.
Fees can really eat into investment returns over the long term so take a serious approach to assessing whether you’re getting good value for money.
And, getting back to gearing, it’s sensible to remember that it can be a negative as well as a positive. On a personal level, borrowing money to invest sounds like it carries extra risk (and it does) so the board should scrutinise a manager’s reasons for doing so.
If it doesn’t feel right to you, that’s no bad thing - we all have our own appetite for risk and it would be worse to stick around in an asset that doesn’t suit you personally.
We’ll finish on this question because it’s one I’ve wanted to clear up. A bit of background first.
OEICs aren’t available on a stock exchange.
You normally have to buy them on an investment platform or directly from an asset management firm and they normally have one dealing point during the day - if you miss it you’ll have to catch tomorrow’s price.
You can’t see the live price of the fund, just the price as of the last dealing point.
The price of a trust works differently - in fact, there are two of them.
The first - Net Asset Value (NAV) - tells us the most recent value of the assets in the trust minus any debts or loans.
The second - share price - tells us what investors are willing to pay right now to own a piece of that collection of stocks.
If the shares are trading below the value of the assets in the portfolio, the trust is said to be trading at a discount.
If shares are trading above that value, they are said to be trading at a premium.
Popular trusts whose shares are in high demand can have high premia because everyone wants a piece of the action.
Trusts with deep discounts can mean investors get to buy into the underlying assets for a lower price than they’re worth.
But, it can also be a sign that investors don’t have much faith in the trust managers, or that it is invested in illiquid assets and there might be doubts over their valuation.
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