What is an investment trust?
Investment trusts offer individual investors access to assets they might otherwise find it difficult to invest in. We look at what an investment trust is, how they work and their advantages and disadvantages.
Investment trusts can be an effective way for investors to put their money to work over the long term but if you’re not familiar with them, they can appear confusing.
They are one of the most popular types of fund among some investors because they have unique advantages, especially when investing in long-term, illiquid areas like real estate or infrastructure.
Beginner investors can think of investment trusts as a form of investment fund, but they have some important defining characteristics. These are explained in greater detail below but in brief, investment trusts:
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- Are actively-managed;
- Can trade at discounts or premiums to the value of the assets they hold;
- Can invest in illiquid asset classes more comfortably than other types of fund, making them useful vehicles for long-term investments;
- Can borrow money to amplify returns (known as ‘gearing’);
- Can smooth dividend payments to shareholders over time.
“Investment trusts are companies, so they have independent boards of directors who look after shareholders’ interests and maximise shareholder returns,” said Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), an industry body that represents investment trusts.
This status as companies in their own right underpins many of investment trusts’ distinctive features: like any listed company, their shares trade in real time on a stock exchange (with their price rising and falling based on market sentiment rather than the value of their assets alone), they can borrow money and they can (to an extent) decide how much of their income they will return to shareholders each year through dividends.
How does active management affect investment trusts?
Investment trusts are active funds with a portfolio manager who sets the trust’s strategy, and is ultimately responsible for its performance.
This governance is important in the running of an investment trust over the long term.
“The board provides oversight of the fund manager and can take action to address performance, or other issues on behalf of shareholders,” said Alex Trett, investment trust research analyst at Winterflood.
Shareholders in investment trusts have a direct say on how it is run. “The great thing about investment trusts versus open-ended funds is, as a shareholder, you can engage with the trust and make your voice heard,” said Tom Treanor, co-manager of MIGO Opportunities Trust. “Every trust has an independent board whose job is to hold the manager to account on performance, fees and capital allocation, and is answerable to shareholders at AGMs and through company votes.”
What is an investment trust discount?
One of the key traits of investment trusts is that they are closed-ended funds, which makes them effective vehicles for investing in long-term growth assets. It also means that the price they trade at isn't directly linked to the value of the assets they hold.
The value of investments like these is often volatile over the short term. Investing in them through an open-ended fund poses a problem when the value of their investment falls: they need to sell assets in order to match the size of the fund to the value of its assets. That can mean selling assets when they are cheap, potentially incurring losses.
But investment trusts don’t have to do this. Their shares trade freely on stock exchanges and there is nothing tying their share price to the value of their assets (net asset value, or NAV).
“Because the act of buying or selling an investment trust does not impact the fixed pool of underlying capital, investment trusts typically trade at either a premium or discount to their NAV, based on the balance of supply and demand,” said Trett.
This is what makes investment trusts useful vehicles for long-term investments; it means that investment trust managers can ride out periodic downturns in their sector, and sell once asset valuations have recovered.
“The investment trust structure is built for the long term,” said Treanor. “Unlike open-ended funds, trusts aren't required to issue or redeem units to match investor appetite, meaning managers are never forced to buy at the top or sell at the bottom to accommodate redemptions.”
Discounts might sound like a downside of investment trusts – but if you buy a trust that is already trading at a discount, you can potentially receive an extra benefit if its performance improves, if the discount narrows at the same time as the underlying asset value rises.
Other investment trust advantages: gearing and dividends
Investment trusts also have other levers they can pull that open-ended funds (open-ended investment companies, or OEICs) and exchange-traded funds (ETFs) can’t, by virtue of their status as listed companies.
“Investment trusts can buy back and issue shares, take on debt and invest the proceeds into the portfolio,” said Andrius Makin, associate portfolio director, fund research at Killik & Co, “all of which should benefit long-term shareholders.”
Taking out debt is known as ‘gearing’, and if the fund manager gets it right, it can lead to superior returns compared to what is possible through other types of funds.
Another key advantage over open-ended funds is around dividend payouts.
OEICS have to pay all their income to their investors every year. In a cyclical sector, that can mean peaks and troughs. Some years you’ll get great returns, but some years you might not get any at all.
Investment trusts can set aside up to 15% of their income every year. In boom years, they can set plenty aside – meaning that they can still pay dividends in bust years, smoothing dividend payments over time.
“There are 20 investment trusts, which we call ‘dividend heroes’, that have increased their dividends consecutively for at least 20 years in a row,” explained Brodie-Smith. “Ten of these have done so for an impressive 50 years or more.”
What are the risks of buying investment trusts?
Many of the unique features of investment trusts have both upsides and downsides. Gearing can increase returns if it goes well, but can also amplify losses if it is used to borrow for assets that then fall in value.
Similarly, if discounts widen rather than narrow after you buy (or if you buy at a premium that then falls), this could impact your returns.
As much as having shareholder rights is a benefit for many shareholders, it can also cause complications.
In April, following a campaign dating back to 2024, activist investor Saba Capital Management won a vote among shareholders in Edinburgh Worldwide Investment Trust (LON:EWI) to replace all of the trust’s board of directors with three new directors it had nominated – having previously been defeated twice by the trust’s shareholders.
While these kinds of corporate activity can potentially increase returns for shareholders over the long term, they can also lead to changes in investment strategy. This might mean a trust’s risk profile and objectives no longer suit other shareholders that had previously bought the trust.
How to invest in investment trusts
Because they are listed companies, shares in investment trusts are bought and sold on stock exchanges just like shares in any other company. You can buy them in a stocks and shares ISA.
Before doing so, it’s advisable to become fully acquainted with any given investment trust and understand the area it invests in, as well as the track record of the portfolio manager.
“Fortunately, because investment trusts are publicly listed, most trusts frequently publish in-depth documentation, and more and more fund managers speak at publicly accessible events,” said Trett. “Interested investors should take advantage of these resources.”
You can buy funds or investment trusts that, themselves, invest in investment trusts. MIGO Opportunities (LON:MIGO) holds discounted investment trusts where its management perceives a potential catalyst to extract value.
“Catalysts – whether tender offers, portfolio sales, redemption offers, special dividends or managed wind-downs – can unlock value that would otherwise remain trapped,” said Treanor.
Similarly, Saba Capital launched an ETF in March – the Saba Capital Investment Trusts UCITS ETF (LON:UKIT) – designed to offer exposure to the discounted UK investment trusts that the hedge fund’s own strategy targets.
