Too embarrassed to ask: what is an investment trust?

When investing in funds you have the choice of a passive fund or an actively managed one. Active funds come in two main varieties, one of which is investment trusts. But what exactly is an investment trust?

When individual investors put money into the stockmarket, they tend to invest using funds. A fund simply pools money from lots of different investors and invests it in a portfolio of assets on their behalf. A passive fund will aim to track an underlying index. An actively-managed fund will try to beat an underlying index or achieve a certain annual return above inflation. 

Actively-managed funds come in two main varieties. There are investment trusts, also known as closed-ended funds. And there are open-ended funds, commonly known as unit trusts. We prefer investment trusts. Why? There are several reasons. But one of the most important differences between an investment trust and an open-ended fund, is that an investment trust is listed on the stock exchange. 

So if you want to invest in an investment trust, you buy shares in the trust itself. This means that the value of the trust is independent of the value of its underlying portfolio, whereas the value of an open-ended fund will always directly reflect the value of its portfolio. 

Why is this a good thing? It means that the investment trust manager doesn’t have to spend lots of time worrying about managing flows of cash in and out of the fund. The investment trust – like any other listed company – raises money by issuing shares. When a new investor wants to come on board, he or she has to buy the existing shares from another holder. The underlying portfolio is untouched. 

With an open-ended fund, it’s different. If you put money in, or take it out, it effectively has to go into or come out of the portfolio itself. So if the manager holds a lot of hard-to-sell assets, he or she runs the risk of being unable to sell quickly enough, if lots of people decide to take their money out at once. This is how star manager Neil Woodford came a cropper in 2019. So arguably, an investment trust manager is more able to take a long-term view when investing.