Investment Trusts

An investment trust is a publicly listed company (plc) that offers an easy way to access a ready-made portfolio of investments carefully picked by a team of experts. 

It is one of the original forms of collective investment. They have been in existence for over 150 years and are still popular. 

Owning a share in an investment trust is an easy way of investing in the variety of assets in a portfolio which commonly include shares in companies, bonds, properties, or private equity. They offer a range of distinctive features that set them apart from other collective investments like mutual funds.

Some of the features and benefits of investments trusts include:

1. Diversified portfolio

As one of the oldest forms of collective investment, investment trusts can invest in a wide range of companies and assets. These are selected to create a portfolio that aims to generate returns in line with its investment objective like capital growth or income generation. This diversification helps to spread the risk and reduces the dependence on the success of one or two companies and can reduce volatility.

2. Gearing

Investment trust are allowed to borrow money to make additional investments. This borrowing is called gearing and it magnifies returns – so in a rising markets gains are higher, however in a falling market, losses will be increased. Typically, investment trusts use modest levels of gearing within clear limits which are set by the board. The investment managers can adjust the levels depending on market conditions or their outlook.

3. Closed-ended structure

This means there is a fixed number of shares in issue at any one time and the manager has a fixed pool of money to invest.

This closed-end investment trust structure provides a level of stability for a portfolio manager who can focus on executing the investment strategy they believe will maximise returns for shareholders. It also means the structure is particularly well suited to managing assets that can be hard to sell quickly.

This is different from some other structures where new assets must be bought if there are inflows and assets sold if investors wish to redeem. Sometimes, prize assets must be sold to fund these redemptions at a time that may not be favourable - or they may be difficult to sell quickly, like property or private equity investments.

4. Income and dividends

Investment trusts are allowed to retain up to 15% of their revenue each year which can be used to boost dividends in years of poor performance. This is called ‘smoothing’ and means that the income levels delivered to shareholders can be less volatile.

5. Discount and premium

Like any company listed on a stock exchange, the price of a share in an investment trust is determined by the buyers and sellers of the shares. This means that the share price does not necessarily match the prevailing value of the assets held in the portfolio, called the Net Asset Value (NAV).

The NAV of a share is the value of all the investment company’s assets, less liabilities such as any debt, divided by the number of shares. If the share price is lower than the NAV, the difference is known as a discount and if it is higher, a premium.

This special feature of investment trusts is attractive to some experienced and professional investors who monitor the discount/premia trends to spot an extra opportunity.

In rising markets:

• If you buy at a discount and the share price rises more than the NAV, (narrowing the discount) you’ll get a better return than the NAV
• If the NAV rises faster than the share price (the discount widens) the value of your investment will increase, but won’t get as good a return as the NAV

In falling markets:

• If the discount widens as the share price and the NAV are both falling, you stand to lose more than the fall in the NAV and potential losses will be increased

6. Independent Governance

Investment trusts are public limited companies (plcs) and have an elected board of directors that is fully independent from the investment manager. The directors’ duty is to look after your interests as a shareholder. They also select a professional investment manager, like Franklin Templeton, to manage the company’s investments.

The directors typically meet several times a year and are accessible to shareholders whom they represent.

7. Shareholders have a say

As a shareholder you own a portion of the investment trust and (just like other plcs) have a direct say in how the company is run. This compares favourably with rights in other collective investments like mutual funds.

Shareholders can:

• Vote on motions at the company’s annual general meeting (AGM)
• Table motions to be discussed
• Call for extraordinary general meetings (EGMs) on important resolutions
• Elect directors and propose new ones if they are not happy with the existing board