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.
Investment trusts are allowed to borrow money to buy shares (known as gearing), which individual trusts do at varying levels thereby affecting the return on your investment and how risky it is.
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.
Comparatively rare today, split-capital trusts (‘Split-Caps’) hit the headlines for all the wrong reasons over a decade ago when several trusts invested heavily in each other and went into a tail spin as markets fell; up until that point zero-dividend preference shares had never failed to meet their final capital obligations and were sold as low-risk investments – their failure delivered a body blow to both the investment trust industry and the advisers that sold the products.
Investment trusts invest in a wide variety of assets via many different financial instruments; some of the oldest trusts date back well over one hundred years and invest in shares from around the world, often delivering both capital growth and income.
By definition, an investment trust delivers a readymade diversified portfolio of investments and still greater diversification can be achieved via a portfolio of investment trusts.
‘an investment trust delivers a readymade diversified portfolio of investments’
Each trust has an investment policy which will influence the way in which it is managed as will the style of the individual trust manager.
Some trusts seek ‘only’ to deliver the performance of an index, whereas others seek to outperform via more active fund management; it is therefore important to find a trust that chimes with your own take on the risk/reward conundrum.
The majority of investment trusts invest in shares, whether in a single country, a region or globally; two management styles that are often quoted are ‘top down’ where the manager considers big picture factors such as regional trends and macroeconomics, and ‘bottom up’ where managers are much closer to the individual companies in which they invest and may apply more rigorous analysis of the businesses.
UK based investment trusts have historically held few bonds for tax reasons and those that do are more correctly ‘investment companies’ rather than trusts, often domiciled in the Channel Islands. Rather than seek to duke it out with mainstream open-ended bond funds, these companies often invest in more esoteric debt products such as convertible bonds, asset-backed securities or senior secured loans.
The structure of investment trusts suits the inclusions of ‘big ticket’ investments such as commercial property or infrastructure projects – assets such as shopping centres or airports cannot be broken up as may be required if investors in open-ended funds head for the exit.
‘The structure of investment trusts suits the inclusions of ‘big ticket’ investments such as commercial property or infrastructure projects’
However, the relative illiquidity of such assets means that when an asset class is out of fashion, shares in the trust may trade at a wide discount to the net asset value (NAV) – the sum of the value of all of the assets owned by the trust.
The ability to ride out the fluctuating fortunes of individual asset classes without having to sell cheaply does add long term stability to investment trusts and in other sectors such as property, shares in trusts often change hands at a premium to NAV because of the attractive income streams that can be achieved.
Private equity – i.e. shares in companies that are not quoted on a stock exchange – is another illiquid asset class that is commonly owned by investment trusts, although in a way that may be less tax-advantageous than Venture Capital Trusts (VCTs), which were established to expressly encourage investment in early stage businesses.
The Association of Investment Companies (AIC) classifies investment trusts to allow them to be filtered according to sector and investment objective; it also shows how trusts perform within their peer group and what their share price represents relative to the NAV of the trust.
Since certain sectors were renamed in 2014 it is possible to make more direct comparison with unit trusts and OEICs. AIC sectors are:
- Global equity/equity and bond sectors: Global; Global Equity Income; Global Smaller Companies; Global High Income. UK equity/equity & bond sectors: UK All Companies; UK Equity Income; UK Smaller Companies; UK Equity & Bond Income.
- Developed market equity sectors: North America; North American Smaller Companies; Europe; European Smaller Companies; Country specialists: Europe; Japan; Japanese Smaller Companies.
- Emerging market equity sectors: Global Emerging Markets; Asia Pacific including Japan; Asia Pacific excluding Japan; Country specialists: Asia Pacific; European Emerging Markets; Latin America; Country specialists: Latin America; Country specialists: Other (currently contains only one fund, Qatar Investment Fund).
- Private equity.
- Hedge funds.
- Property sectors: Property securities; Property direct – UK; Property direct – Europe; Property direct – Asia Pacific; Property specialist.
- Sector specialist (equity or debt) sectors: Biotechnology & Healthcare; Commodities & Natural Resources; Debt; Environmental; Financials; Forestry & Timber; Infrastructure; Infrastructure – Renewable Energy; Insurance & Reinsurance Strategies; Leasing; Liquidity Funds; Litigation; Tech, Media & Telecom; Small Media, Comms & IT.
- Venture Capital Trust (VCT) sectors: VCT Generalist; VCT Generalist Pre-qualifying; VCT AIM Quoted; VCT Specialist Environmental; VCT Specialist Environmental Pre-qualifying; VCT Specialist Infrastructure; Pre-qualifying; VCT Specialist Media, Leisure & Events; VCT Specialist Media, Leisure & Events Pre-qualifying; VCT Specialist Technology; VCT Specialist Technology Pre-qualifying