Inside Investment Trusts
We look at the difference between investment trusts and unit trusts and OEICs and consider the benefits of a professionally managed portfolio that is instantly diverse in terms of the asset types and sectors it invests in.
Investment trusts are investment companies that trade on the London Stock Exchange and their share price is determined by the market; investment trusts can retain a proportion of the income they receive in good years to pay dividends in lean times.
Many trusts have delivered year-on-year increases in their dividend for many decades which may make them attractive to income investors.
DIY Investor suggests some of the key factors that may inform your choice and a wide range of investment trust managers share the vision they have for their fund and why you might consider investing in it.
What are Investment Trusts?
Investment trusts are collective investment vehicles that pool investors’ money to purchase a range of assets in a similar fashion to unit trusts and OEICs, but because they are structured in a different way they are considered here as a separate asset class.
Investment trusts deliver an instantly diverse portfolio of investments with risk spread across different regions, industry sectors and asset types; they are set up as individual companies, run by a board of directors and quoted on the London Stock Exchange, but unlike other collective investments they are ‘closed ended’ in that they issue only a limited number of shares.
Unlike unit trusts and OEICs which create and cancel units according to demand, for an investor to be able to buy into an investment trust there has to be a seller.
Shares in investment trusts are a product of market supply and demand rather than as a fraction of the net asset value of the trust’s holdings.
Investment Trusts vs Unit Trusts
Investment trusts, unit trusts and open ended investment companies (OEICs) are actively managed collective investment funds.
Unit trusts are known as ‘open-ended funds’ on the basis that they grow or contract in line with demand; investment trusts are ‘closed-ended funds’ because they raise a set amount of cash and issue a set number of shares; for there to be a buyer in an investment trust there has to be a seller.
Units in unit trusts reflect the net asset value (NAV) of the assets within the fund; the price of a share in an investment trust is set by the market.
Each investment trust has a board of directors and is listed as an investment company on the London Stock Exchange; their shares are traded just like any listed company.
Investment trusts outperform unit trusts in most sectors over periods of ten years or more but may display greater volatility.
Investing in Investment Trusts and Unit Trusts
You do not have to choose between unit trusts and investment trusts, many investors hold both in a balanced portfolio; the most important thing is not the type of vehicle, but the manager’s ability to outperform the market.
The DIY investor looking for a potentially higher return than from a unit trust or OEIC, willing to take a little more risk and happy to tie up their money for at least five years may consider investment trusts.
Unlike unit trusts, investment trusts trade freely on the stock exchange and there is therefore immediacy and transparency in the bid and the offer prices; unit trusts are priced once a day with the unit prices set at the net asset value (NAV) of the fund divided by the number of units.
Regular valuations allow a would-be investor to calculate whether or not an investment trust is ‘undervalued’ – i.e. the price of each share is less than the value of all assets held in the company divided by the number of shares.
Types of Investment Trusts
Conventional Investment Trusts
Investment trusts are constituted as public limited companies and issue a fixed number of shares; because of this they are referred to as closed ended funds.
A trust’s shares are traded on the stock exchange like any public company and the price of its shares depends on the value of its underlying assets and the demand for them.
Conventional investment trusts offer just one share class which is aligned to the objective of the trust – typically whether to target capital growth or income.
Split Capital Investment Trusts
These run for a specified time, usually five to ten years, and issue different types of shares which pay out at the end of their term, in order of share type.
You can choose a share type to suit you – typically the further down the pecking order in terms of payment the share is the greater the risk, but the higher the potential return.
Income shares pay investors dividends during the trust’s life whilst zero-dividend preference shares, deliver no income during the trust’s life, but pay out a set value at maturity; this is paid as a capital gain, which may be preferable to income from a tax perspective to some investors.
At the risky end of the spectrum, capital shares pay no income but entitle holders to all remaining assets once other shareholders have been paid back – if any remain.
Investment Trust Savings Schemes
Investment Trust Savings Schemes (ITSS) are low cost plans that deliver diversified exposure to the stock market for regular investors.
An ITSS enables the investor to embark upon a long term investment strategy by making small regular investments into the stock market; some from as little as £10 per month.
The schemes tick two of the most important boxes for a successful investment strategy – they can accumulate a significant sum over the period of a long term investment and the cost of ownership is low.
Over the longer term the investor will acquire shares in the scheme at differing prices, according to the level of the market at the time of purchase; the invested sum will buy fewer shares when the price is high and more when the price falls.
One of the keys to success with any investment strategy is keeping costs as low as possible, and that is a particular strength of ITSS; they typically have either very low, or no, dealing costs – often charging just Stamp Duty at 0.5% – which is a considerable advantage over other investments.
The level of risk and return will depend on the investment trust you choose. Find out what type of assets the trust will invest in, as some are riskier than others.
Look at the difference between the investment trust’s share price and the value of its assets as this gap may affect your return. If a discount widens, this can depress returns.
Find out if the investment trust borrows money to buy shares. If so, returns might be better but your loses greater.
With a split capital investment trust, the risk and return will depend on the type of shares you buy.
You can sell your shares at any time, although investment trusts are most suitable for long-term investments (over five years). You will have to pay a stockbroker to buy and sell them.
Investment trusts will charge an Annual Management Charge (AMC).
As with any quoted share, an investment trust price will be quoted with a ‘bid offer spread’ – you’ll get a different price if you’re selling to what you’ll pay if you’re buying.
Any income paid is taxed at the same level as other shares. Dividends are paid with a 10% non-reclaimable tax credit that satisfies any liability for starting rate or basic rate income tax. If you’re a higher rate or additional rate taxpayer, there is further tax to pay.
Any profit you make from selling shares is usually subject to Capital Gains Tax.
But many investment trusts are available within an ISA (sometimes called NISA), which means dividends are paid with a 10% non-reclaimable tax credit that satisfies any liability for basic and higher rate income tax as well as Capital Gains Tax on your profits
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Henderson brings you one (largely unknown) corner of the investment market that may be perfect for your ISA: investment trusts …..more