Investment trusts are a popular investment option in the UK, but many people aren’t familiar with how they work or how they can fit into their investment strategy. Whether you’re a seasoned investor or just starting out, understanding the basics of investment trusts is essential for making informed decisions about your portfolio. In this guide, we’ll explain what investment trusts are, how they differ from other types of investments, and the potential benefits and risks they offer.
What is an Investment Trust?
An investment trust is a type of collective investment scheme, meaning it pools money from multiple investors to buy a diverse range of assets, such as stocks, bonds, or property. These trusts are listed on the stock exchange and are traded just like shares of individual companies.
Investment trusts allow individual investors to gain exposure to a broad range of assets without needing to buy them individually. The trust is managed by a professional fund manager, who makes investment decisions on behalf of the investors in the trust.
How Does an Investment Trust Work?
Investment trusts work by issuing shares to investors, which represent a portion of the trust’s holdings. The money raised from investors is then used by the fund manager to buy a portfolio of assets.
One key feature of investment trusts is that they are closed-ended. This means that once the shares are issued, they are traded on the stock market, and their price fluctuates based on supply and demand, rather than the value of the underlying assets. The price of an investment trust’s shares can therefore be higher or lower than the net asset value (NAV) of the underlying assets.
How is an Investment Trust Different from a Mutual Fund?
While investment trusts and mutual funds share similarities, such as pooling investors’ money to buy a diversified range of assets, there are a few key differences:
Structure: Investment trusts are closed-ended, meaning they have a fixed number of shares. Mutual funds are open-ended, meaning the number of shares can vary depending on how many investors buy or sell.
Trading: Investment trusts are traded on the stock exchange like individual shares. This means you can buy and sell shares throughout the trading day at the prevailing market price. In contrast, mutual funds are bought and sold based on the NAV at the end of the trading day.
Discounts and Premiums: Investment trusts can trade at a discount or premium to their NAV, depending on market conditions. This means you might be able to buy an investment trust at a lower price than its underlying assets are worth, or you might pay more. Mutual funds, on the other hand, are always bought and sold at their NAV.
Income Distribution: Investment trusts often pay regular dividends to investors. Because they are managed by a fund manager, these distributions can be more consistent than those from mutual funds, which may fluctuate.
What Are the Benefits of Investment Trusts?
Diversification: One of the main advantages of investment trusts is that they allow investors to gain exposure to a wide range of assets, which can reduce risk. By pooling funds with other investors, you can access assets you may not be able to afford on your own.
Professional Management: Investment trusts are managed by professional fund managers who make decisions on which assets to buy or sell, based on their expertise and market research.
Discount Opportunities: As mentioned earlier, investment trusts can trade at a discount to their NAV, meaning you may have the opportunity to buy into a trust at a lower price than the underlying assets are worth.
Income Generation: Many investment trusts pay regular dividends to shareholders. If you’re looking for a source of income from your investments, an investment trust may be an attractive option.
Liquidity: Since investment trusts are traded on the stock exchange, they are more liquid than some other types of investments, such as property funds. This means you can easily buy and sell shares whenever the market is open.
What Are the Risks of Investment Trusts?
Like all investments, investment trusts come with risks. Some of the main risks include:
Market Risk: The price of investment trust shares can fluctuate based on market conditions. If the value of the underlying assets falls, the price of the investment trust shares may also decline.
Discounts and Premiums: Investment trusts can trade at a discount or premium to their NAV, meaning you might end up paying more or less for the trust than its underlying assets are worth. This can make it more difficult to assess the value of the trust.
Management Risk: The performance of the investment trust depends on the skill of the fund manager. If the manager makes poor investment decisions, the value of the trust may decline.
Leverage: Some investment trusts use leverage (borrowed money) to boost their returns. While this can amplify gains, it can also increase losses if the investments don’t perform as expected.
How Can You Invest in an Investment Trust?
Investing in an investment trust is relatively simple. You can buy shares in an investment trust through:
Stockbrokers: Most stockbrokers offer a wide range of investment trusts for investors to choose from. You can buy shares in a trust just like you would for any other listed company.
ISA or SIPP: You can also invest in investment trusts through tax-efficient accounts, such as an Individual Savings Account (ISA) or a Self-Invested Personal Pension (SIPP), which may provide tax benefits.
Robo-Advisors: If you prefer a hands-off approach, some robo-advisors offer investment trusts as part of their portfolios.
Final Thoughts
Investment trusts can be a great way to diversify your investment portfolio, gain access to professional management, and generate income through dividends. While they come with risks, understanding how they work and what to look for can help you make an informed decision about whether they are right for you.
When considering an investment trust, make sure to compare different providers, check the performance of the trust over time, and ensure it aligns with your financial goals. Whether you’re looking for growth, income, or diversification, there’s likely an investment trust that can meet your needs.
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