Anyone coming to investment trusts for the first time can find some of the terminology and the vagaries of their structure difficult to fathom. How do they work, compared with funds? What are their attractions for private investors, and in what contexts can they work particularly well?
Investment trusts have a lower profile than funds, partly because there are far fewer of them. Money Observer tracks the performance of around 400 UK and overseas-domiciled trusts and investment companies, compared with around 2,300 investment funds.
Nonetheless, as a glance at our 10 magazine pages of statistics reveals, there are trusts to cover all the main sectors, regions and strategies, as well as a wide range of more esoteric areas usually avoided by funds.
INVESTMENT TRUST TYPES
In a nutshell, trusts are set up as listed companies issuing shares that can be traded on the London Stock Exchange. Like any company, they issue a fixed number of shares - hence the term 'closed-ended' - to raise capital that the manager allocates to investments.
If shareholders in the trust want to sell shares, their decisions don't impact directly on the value of the manager's pot, enabling a relatively long-term view in investment decisions.
In contrast, unit trusts and Oeics have an open-ended structure, which means the fund manager simply creates more units when more people want to own that fund, and vice versa.
That can cause problems for the manager, for example if there's a run on the fund and holdings have to be sold (perhaps at a low price) to raise the cash needed as investors sell their units.
Trusts' closed-ended structure means investors need to bear two prices in mind: the share price, which goes up and down according to investor demand and supply, and the value of the underlying assets, known as the net asset value (NAV).
DISCOUNTS AND PREMIUMS
In most cases, the share price is lower than the underlying value of the assets, and the trust is said to be trading at a discount. That means investors are paying less than face value for the trust.
If the discount then narrows - for example, because growing demand is driving the share price up towards NAV - their investment receives a boost on top of that linked to performance from the underlying assets.
Of course, the share price movement could go the other way and the discount widen. Practised trust investors watch for buying opportunities, in the shape of well-regarded trusts on uncharacteristically wide discounts that are likely to narrow over time.
Our databank includes 12-month highs and lows for discounts and premiums, to show investors how current values compare with the recent range.
Gearing, or borrowing, is something open-ended fund managers are not allowed to do. Borrowing to invest more at opportune times can lift returns per share by more than the cost of the loan per share. But if the market falls, investors in geared trusts may lose more per share than those in ungeared trusts.
Over the long term and on average, investment trusts tend to deliver better returns than unit trusts and Oeics.
Trusts have an additional advantage for income-seekers: unlike open-ended funds, they are able to hold back up to 15 per cent of the dividend income received from underlying holdings each year, and use it to supplement or 'smooth' their payouts in leaner years.
FOUR REASONS WHY AN INVESTOR MIGHT CHOOSE A TRUST
To gain broad exposure
If you're starting from scratch or saving for a child, some of the big generalist trusts in the global sector offer broad, reliable exposure to a wide range of countries and sectors.
Adventurous investors looking for a route into focused industry sectors such as biotechnology or single countries such as China, India or Brazil can find trusts to suit their needs.
To invest in illiquid assets
Trusts can work well for investment into illiquid sectors such as direct property, private equity or infrastructure, where transactions tend to be slow-moving and investment timescales longer-term.
To grow dividends
Income-seekers who want the reassurance of a steadily increasing payout are well catered for: the Association of Investment Companies has identified 10 trusts with a 40 year-plus record of annual dividend increases for such investors.