Investment trusts can be a very effective way for investors to put their money to work over the long term, but they can appear confusing at first glance.
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.
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“The board provides oversight of the fund manager and can take action to address performance, or other issues on behalf of shareholders,” says Alex Trett, investment trust research analyst at Winterflood. That can include corporate activity like changing the manager, amending the investment strategy or even proposing that the investment trust merges with another fund or winds down and returns capital to investors.
What are the advantages of investment trusts?
One of the key traits of investment trusts is that they are closed-ended funds, which makes them very effective vehicles for investing in long-term growth assets.
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 means 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,” says Trett.
This means that investment trust managers can ride out periodic downturns in their sector, and sell once asset valuations have recovered.
Investment trusts also have other levers they can pull that open-ended funds (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,” says 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 fund.
Makin also believes that the governance structure of investment trusts is an under-appreciated advantage compared to other types of fund.
“As an investor, you are a shareholder, which comes with rights, such as the right to vote on how the trust is managed at the annual general meeting (AGM),” he says. Shareholder rights like these give investment trust shareholders a say in trust direction that they don’t have if they buy an OEIC or an ETF.
What are the risks of buying investment trusts?
Because of their closed-ended nature, investment trusts can trade at below the total value of their investments for prolonged periods of time. That effectively reflects pessimism from the market about the ability of the manager to outperform the wider market, though it is also a consequence of the lag involved in valuing some forms of asset.
Gearing, if the manager gets it wrong, can also amplify losses and volatility.
Then there is what Makin calls the “disruption factor”. As much as having shareholder rights is a benefit for many shareholders, he says, it “requires investors to engage with their holdings by voting on resolutions at AGMs.
“This is generally beneficial, but not everyone has the time to do this.”
Do investment trusts pay dividends?
Investment trusts – like any listed company – can pay dividends to their shareholders.
They also have another key advantage over open-ended funds when it comes to 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, called dividend heroes, that have increased their dividends consecutively for at least 20 years in a row,” says Brodie-Smith. “Ten of these have done so for an impressive 50 years or more.”
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 into a stocks and shares ISA.
Before doing so, it is 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,” says Trett. “Interested investors should take advantage of these resources.”
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