What is an investment trust, and how does it work?

If you’re thinking of investing in an investment trust, there’s a lot to consider.

We look at what an investment trust is, how it works, the pros and cons and how to buy and sell them.  

What is an investment trust? 

An investment trust, which is among the oldest collective investments, is similar to an investment fund as it comprises various individual investments chosen and overseen by a manager. 

However, unlike other collective investments, such as open-ended investment companies (OEICs) and unit trusts, an investment trust is a public limited company listed on the London Stock Exchange. 

Some trusts have minimum and maximum investment limits, and it’s worth remembering that your investment can rise and fall in value. 

How does an investment trust work? 

When you get involved with an investment trust, your money is grouped together with contributions from other people. An investment manager then uses the funds to buy a portfolio of investments.  

By doing this, you can access a huge range of investment opportunities.  

When you invest in an investment trust, you become a shareholder, and as there are only a limited number of shares, it’s closed-ended. 

Opportunities and risks to consider 

While some investment trusts may have a long-term view worldwide, others may specialise in a specific country or region.  

However, it’s important to remember that if you are considering buying foreign investments, there is a currency risk – you could lose money if there are unfavourable exchange rates. 

You should also be aware of ‘gearing,’ which is when investment trusts borrow money to buy more shares or assets to benefit from a potential rise in the value of a particular area or share. 

While this can boost the value of your investments, gearing can make losses worse if share prices fall. 

It’s a good idea to research the opportunities and risks of investing in an investment trust or talk to a financial adviser who can offer vital guidance. 

How supply and demand affect investment trusts 

Supply and demand impact an investment trust’s share price.  

It’s a good idea to look at the net asset value (NAV), which is the value of assets in an investment trust minus any debt, and divided by the number of shares.

If the share price is more than the NAV, the investment trust trades at a premium, and if it’s less than the NAV, it’s trading at a discount.

So, if an investment trust is investing in popular, out-of-favour or struggling areas, or there’s little confidence in management, this could impact whether it’s trading at a discount or a premium.

What are the pros and cons of investment trusts? 

Before you get involved with investment trusts, it’s worth exploring the advantages and disadvantages. 

The pros of investment trusts

• The ability to access many companies or geographic areas via one investment.

• The ability to trade investment trusts using live prices.

• An experienced management team that manages the trust and an independent board of directors that represents shareholders’ interests.

• The opportunity to buy shares at a lower price if the investment trust trades at a discount (and you’re optimistic about future prospects).

• A closed-ended structure that doesn’t allow money to flow in and out of the trust unpredictably.

• The right to vote on important issues as you’re a shareholder.

• An increased likelihood of predictable dividends as investment trusts can keep up to 15% of net income annually, so future payments can be made if markets become challenging.

• The chance of boosting your returns via gearing (but this can increase losses if the share price falls). 

The disadvantages of investment trusts

• You're committing to a long-term investment, so it isn’t ideal for those planning to invest for under five years.

• Gearing, which can amplify any losses in falling markets, as well as boost returns.

• Potentially being charged a share trading fee for buying investment trusts. Annual management fees can also be higher than other investments.  

How to buy and sell investment trusts 

You can buy investment trusts during stock market hours at live prices if you have an individual savings account (ISA), self-invested personal pension (SIPP) or dealing account. 

The first two options are worth considering as they protect your investments from tax, while any gains or income you make from investments in a dealing account may be subject to tax.  

If you don’t use an ISA or SIPP and use up your tax allowances, you may have to pay tax on any dividends and profits, as well as capital gains tax (CGT) if you sell your shares for a profit.

Where to buy investment trusts and what it costs

You can buy investment trusts directly or use an investment platform or online broker. Alternatively, a financial adviser can offer advice and purchase an investment trust for you. 

There’s a fee for buying and selling shares, management charges and possibly account and platform fees. So, it’s worth shopping around and comparing fees so they don’t eat away at your returns.  

Want to sell an investment trust? You can do this directly, via an investment platform or ask your adviser, but you may incur an exit fee, so it’s worth checking beforehand.  

Should I invest in an investment trust? 

Whether or not an investment trust is right for you depends on your financial goals and attitude to risk. As with investing in general, a long-term view is vital. 

It’s vital to do your research, looking at the areas where your desired investment trust focuses on, past performance, expected returns, the risk appetite and fund manager’s performance.  

If the investment trust is trading at a premium or discount, it’s a good idea to explore why this is and what factors could affect this. 

If you’re considering investing in an investment trust and are looking for guidance, a financial adviser can help.

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