What is an Investment Trust?

• Long-term view: They have a fixed number of shares (so they’re known as ‘closed-ended’), meaning they don’t have money flowing in and out unpredictably. This gives the portfolio manager a high level of control and the flexibility to build a long-term strategy, as they’re able to invest and sell when they feel the time is right.
• Diversifies your investments: With a stake across hundreds of companies, you’re not reliant on the fortunes of just one or two businesses.
• Acts in your interests: When you invest in an investment trust, you become a shareholder in that company, giving you more rights and protection than unit holders in funds such as unit trusts. It also gives you the right to vote on issues such as the appointment of directors and key company policies, as well as the ability to attend the Annual General Meeting (AGM). Each investment trust has an independent board of directors which has been appointed to look after shareholders’ best interests.
• Low costs: They have a reputation for low charges, partly as annual charges are paid out of a trust’s assets instead of an investor’s account.
• Income consistency: They’re able to retain up to 15% of their net income each year, giving them the ability to smooth these payments over the years. For example, they may be able to ‘top up’ the income that investors receive in years when the portfolio’s income is lower than average.
• Borrowing power: By borrowing money (a process known as ‘gearing’), investment trusts can potentially boost returns, though it can also magnify losses.

Investment trusts can borrow money in order to buy investments, in a process known as gearing. It can magnify the trust’s performance, but this happens whether it rises or falls in value, so it can boost gains or increase losses.

It’s important to remember that the interest has to be paid on the borrowed money, whether or not the trust makes a profit on the loan.

The net asset value (NAV) is the value per share of all the assets owned by the investment trust. That is, the combined value of all the assets.

They’re affected by supply and demand, as their shares are listed on the London Stock Exchange – essentially, market demand. This means that share prices may be bought and sold higher or lower than the NAV.

Changes in the difference between the NAV and the share price can magnify the gains or losses on your investment.

If you pay less than the NAV for your shares, you’re buying at a “discount”. If you pay more, you’re buying at a “premium”. However, the discount can change, meaning there is an extra level of risk in buying investment trust shares.

Discounts widen when the share price falls further behind the NAV, which can happen whether the market is rising or falling. In a rising market, shareholders may not notice a widening discount because the share price will often still be going up. However, if discounts widen when the NAV falls, it magnifies the loss.

Of course, the opposite is true. In some circumstances, the discount can narrow while the NAV falls, which reduces the overall loss.

Take a look at the table below for a quick overview:

	Investment trusts	OEICs	Unit trusts
Structure	Closed ended	Open ended	Open ended
Available in an ISA & SIPP
Independent board of directors
Fixed number of shares
Manager's option to borrow

Like all funds, investment trusts can rise and fall in value. However, they have more factors affecting their performance (such as supply and demand), which can mean they are more volatile and, therefore, a more risky investment.

As a result, investors need to take a range of factors into account when looking at an investment trust. In addition to the risk that the market as a whole will rise or fall, an investor needs to think about:

• how the trust’s portfolio will perform against the market
• what the current discount or premium is and where it might be heading
• whether the manager has the ability to provide positive returns in the future
• what extra volatility or risk will be created by the trust’s gearing

One of the reasons trusts tend to trade at a discount is because there is a perception that their shares can be difficult to buy or sell on occasion (in other words, they’re less liquid) as, unlike funds, a buyer must be found in order to sell your shares.

However, boards have focused more and more over the years on ways to improve liquidity in order to help close the discount to shareholders’ benefit.

In order to give our customers even more peace of mind, we’ve also ensured that all the trusts we offer have market capitalisations of around £100 million or more. This should mean there are enough shares in circulation to avoid the risk of investors not being able to sell when they want to.