Investment trusts that are not necessary are about to face consequences

According to Kaylie Pferten, investment trusts that fail to capitalize on their structural advantages will have a harder time surviving

Investment trusts are among the best ways to build wealth over time. However, a lot of today's trusts shouldn't be in place. Some lack economies of scale and are too tiny to have an impact. The advantages of the investment company structure are not being fully utilized by others.

Compared to other collective investment vehicles, an investment trust has various advantages because it is established as a public limited company. They don't have to worry about money coming in and going out because of their closed-ended structure and fixed capital. That is ideal for both borrowing money to increase returns and holding illiquid assets. If the trust performs poorly for an extended period of time, the board of directors' supervision ought to hold the investment manager responsible.

But there are two clear problems with this structure. The first is overheads. The cost of having a separate board of directors is high. Illiquid asset management and valuation can also be expensive and time-consuming. It has never been inexpensive to pay for active investment managers, and it is even more expensive if the trust has an internal management team as opposed to sharing a manager who oversees multiple funds. Due to the combined effect of these expenses, many smaller trusts appear pricey to their larger counterparts or open-ended funds using similar strategies.

The share price can, and typically does, diverge from net asset value (NAV). As a result, shareholders cannot be certain that they will be able to sell their assets for nearly their full value. Exchange-traded funds (ETFs) and open-ended funds, on the other hand, trade at NAV.

Investment trusts must begin utilizing their advantages.

Trusts must therefore use their benefits to offset the drawbacks. Consider leverage, which is one of the reasons trusts have historically outperformed comparable open-ended funds in the long run. Trusts are typically able to borrow money for extended periods of time at very appealing rates. For instance, a few years ago, the Scottish American Investment Company (LSE: SAIN) issued three lots of loan notes with maturities ranging from 2.23 percent to 3.12 percent. However, the majority of trusts simply fail to take full advantage of this chance.

Despite its size and the managers' conviction, Nick Trains Finsbury Growth and Income (LSE: FGT) has a gearing of only 2.4 percent. Therefore, it is necessary for boards, managers, and investors to inquire as to whether the strategy would be equally effective in an open-ended structure. The answer is probably yes for an equity strategy that invests in liquid stocks and doesn't use any leverage. In that case, operating with the additional expenses of the investment trust structure is not necessary. An excellent illustration of this lesson being applied is the announcement that Smithson Investment Trust (LSE: SSON) will become an open-ended fund.

Investment trusts have to move quickly.

The market is gradually realizing these facts. The Association of Investment Companies reports that there were five mergers of comparable trusts in 2025 and one more is scheduled for early 2026. Long-term investors were unhappy to see some of the seven trusts and real estate investment trusts (Reits) that were privatized, such as BBGI Global Infrastructure. In 2025, there were 14 liquidations, the most since 2016. One of them, Middlefield Canadian Income, was converted to an exchange-traded fund (ETF).

To their credit, some trusts are changing. Compared to 32 in 2024 and 26 in 2023, there were forty instances of trusts lowering their fees this year. Closing discounts are receiving more attention, though the outcomes are not entirely consistent. However, a lot of people need to take more action while they still can.

Investors ought to think about whether the trusts they own are worth listing on the market. If they aren't, it might be time to look for something better unless there is a plausible possibility that activists will force a reorganization that could result in windfall profits.