An investment trust: what is it?

Through investment trusts, individual investors can access assets that they might otherwise find challenging to invest in

We examine the definition, operation, and benefits and drawbacks of investment trusts.

Although investment trusts can seem confusing at first, they can be a very effective way for investors to put their money to work over the long term.

Because they offer special benefits, particularly when investing in long-term, illiquid sectors like infrastructure or real estate, they are among the most well-liked fund types among certain investors.

Although investment trusts have some key features, novice investors may consider them to be a type of investment fund.

A portfolio manager establishes the strategy for investment trusts, which are active funds, and is ultimately in charge of the trust's performance.

"Being businesses, investment trusts have independent boards of directors that protect the interests of shareholders and maximize returns," says Annabel Brodie-Smith, director of communications for the Association of Investment Companies (AIC), a trade association that advocates for investment trusts.

Long-term management of an investment trust depends on this oversight.

According to Alex Trett, an investment trust research analyst at Winterflood, "the board monitors the fund manager and has the authority to take action to address performance or other issues on behalf of shareholders." This can involve corporate actions such as switching managers, modifying the investment plan, or even suggesting that the investment trust wind down and give investors their money back or merge with another fund.

What benefits do investment trusts offer?

The closed-ended nature of investment trusts is one of their primary characteristics, which makes them excellent investment vehicles for long-term growth assets.

These kinds of investments frequently have short-term volatility in value. An issue arises when they invest in them through an open-ended fund because they have to sell assets to bring the fund's size down to the value of its assets. In other words, selling assets at a discount could result in losses.

Investment trusts, however, are not required to do this. On stock exchanges, their shares are freely traded, and their share price is not correlated with the value of their assets (net asset value, or NAV).

"Depending on supply and demand, investment trusts usually trade at a premium or discount to their NAV because the act of purchasing or selling one does not affect the fixed pool of underlying capital," Trett explains.

Accordingly, managers of investment trusts are able to weather recurring downturns in their industry and sell when asset values have increased.

Additionally, because they are listed companies, investment trusts have additional levers that open-ended funds (OEICs) and exchange-traded funds (ETFs) cannot pull.

According to Andrius Makin, associate portfolio director, fund research at Killik and Co., "investment trusts can buy back (and issue) shares, take on debt, and invest the proceeds into the portfolio," all of which should be advantageous to long-term shareholders.

Gearing, or taking out debt, can result in better returns than other fund types if the fund manager does it correctly.

When compared to other fund types, Makin thinks that investment trusts' governance structure is an undervalued benefit.

"You have rights as a shareholder as an investor, including the ability to vote at the annual general meeting (AGM) on how the trust is run," he says. These kinds of shareholder rights provide investment trust shareholders with a voice in trust direction that they would not have if they purchased an ETF or an OEIC.

What dangers come with investing in trusts?

For extended periods, investment trusts may trade below the total value of their investments due to their closed-ended nature. That accurately captures the market's skepticism regarding the manager's capacity to beat the overall market, but it also results from the delay in valuing some asset types.

Inadequate gearing by the manager can also increase volatility and losses.

The "disruption factor" is another; Makin refers to it as such. He claims that while many shareholders benefit from having shareholder rights, doing so "requires investors to engage with their holdings by voting on resolutions at AGMs."

Although not everyone has the time, this is generally advantageous.

Investing trusts: do they pay dividends?

Investment trusts are able to distribute dividends to their shareholders, just like any other publicly traded company.

Regarding dividend payments, they also have a significant edge over open-ended funds.

Every year, OEICS is required to distribute all of its profits to its investors. That may entail peaks and troughs in a cyclical industry. You may not receive any returns at all in some years, but you will receive excellent returns in others.

Up to 15% of an investment trust's annual income may be set aside. Their ability to set aside large sums of money during boom years allows them to continue paying dividends during bust years, thereby distributing them evenly over time.

Brodie-Smith identifies 20 investment trusts, referred to as "dividend heroes," that have raised their dividends for a minimum of 20 years in a row. For an astounding fifty years or longer, ten of these have been doing this.

The process of investing in investment trusts.

Investment trust shares are bought and sold on stock exchanges like shares of any other company because they are listed businesses. They can be purchased into an ISA for stocks and shares.

Prior to doing so, it is best to learn everything there is to know about the investment trust in question, including its investment area and portfolio manager's performance history.

According to Trett, "most investment trusts regularly publish in-depth documentation and more and more fund managers speak at publicly accessible events because investment trusts are publicly listed." "These resources should be utilized by prospective investors.