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 and can operate differently they are considered here as a separate asset class.
Just as with unit trusts and OEICs, investment trusts deliver an instantly diverse portfolio of investments with risk spread across different regions, industry sectors and asset types.
A key difference is that investment trusts 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.
Because an investment trust is technically a company, it has a board of directors – a feature not shared by open-ended funds. The role of the board is to set the investment policy and ensure it is adhered to. The board appoints the fund manager, and has the power to seek a new manager if results are not as expected.
The board will also decide the gearing policy (the extent to which a trust can borrow money to invest), the level of dividend, and may implement a discount management policy to ensure the share price does not deviate too far from the NAV. Board members are usually independent of the fund management company, and may have specific expertise in areas such as accountancy, or experience in the region or asset class in which the trust invests.
‘investment trusts deliver an instantly diverse portfolio of investments’
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.
This can be seen as giving an advantage to investment trusts because its investment managers can take a long term, strategic view, without having to liquidate assets when investors sell out or indeed buy assets at inflated prices in times of high demand.
Shares in an investment trust are readily traded like any company share and the price you will pay is a reflection of the market’s valuation of the share rather than a calculation of the net asset value (NAV) of the fund divided by the number of shares as in the open-ended model.
This means that share can either trade above NAV – at a ‘premium’ – or below NAV – at a ‘discount; this is a reflection of market sentiment about a particular trust – investors will pay more than the sum of its parts to get into a desirable fund, but will only buy into less attractive funds for less than the value of the assets they hold.
This can be seen as an opportunity for those seeking latent value in a business, because buying an investment trust at a discount effectively means that you are paying below market price for the assets it holds.
‘Trading at a discount could be a sign that investors do not believe in the manager’s ability’
Trading at a discount could be a sign that investors do not believe in the manager’s ability, do not believe the valuation of its underlying assets or do not believe that the assets it holds are sufficiently liquid to achieve their market valuation.
Investment trusts are wary of the negative connotations of trading at a discount and may buy its own stock to fuel its share price; investment trusts regularly issue updates to the value of its holdings and so it is simple to see if they trade at a discount or indeed at a premium.
Then it is a value judgement – do you buy into a trust that the market has down valued in the hope that it will come back, or do you look for one which investors are prepared to pay over the odds for and hope that its momentum continues?
Another key difference is the way in which investment trusts treat income from dividends it receives.
Unit trusts and OEICs either distribute the income they accrue – ‘income’ funds – or reinvest it into the fund to boost the value of its units – ‘accumulation’ funds; investment trusts are different on the basis that the can retain up to 15% of their income in bountiful years to ensure that they can not only pay a dividend, but hopefully increase their dividend, in lean times.
‘Many investments trusts have been consistently increasing the dividends they pay over decades’
Investment trusts can also leverage its cash reserves in the hope that it can magnify returns on other investments and thus increase the fund.
Many investments trusts have been consistently increasing the dividends they pay over decades – a potentially powerful pull factor for those seeking income.
Henderson’s City of London Investment Trust has increased its dividend year on year since England won the Football World Cup in 1966; whilst past performance may be no guarantee of future returns, if you decided to join that particular party the odds of the trust continuing to increase its dividend in the future are probably better than that of England repeating its feat.
As with unit trusts and OEICs there are investments trusts that specialise in particular markets, industry sectors or asset types and you may be able to find exposure to investments that are otherwise difficult to access; investment trusts are actively managed and seek to ‘beat the market’.
Figures from trade body the Investment Association show that £1.2 trillion was invested in 2,538 UK-domiciled open-ended funds at the end of November 2017.
Investment trusts have been around for longer – the first one, Foreign & Colonial Investment Trust, was launched in 1868 – its 150th anniversary this year – whereas the first unit trust, M&G First British Fixed Trust, did not appear until 1931.
However, despite its long history, the investment trust sector is comparatively small: the Association of Investment Companies says £174.4 was invested in 389 closed-ended funds at the end of December 2017.
This is largely historical as pre-RDR, most open-ended funds paid commission to financial advisers, while investment trusts did not.
However, there are some specific characteristics of investment trusts that make them more complex than open-ended funds, which may also account for some of the disparity.
As listed companies, investment trusts publish annual and half-yearly reports and accounts, delivering a wealth of information on the portfolio and performance of the trust.
Investment trusts also hold annual general meetings for shareholders, where investors can influence investment policy and performance, discount management and directors’ remuneration.