What is an “Investment Trust”?
Investment trusts are investment companies that trade on an exchange just like other equities – investors can purchase or sell company shares from the market. They are closed-ended in nature and the share price is determined by supply and demand rather than the value of underlying assets.
Therefore, Investment trusts can trade on a discount or premium to their Net Asset Value (NAV). In addition to that, they can use gearing to enhance their return. As investment trusts have a fixed number of shares and do not need to manage in and outflows like the open-ended funds, their managers have a higher level of control and can take a longer-term view in building their strategy.
Key Learning Points
- Investment trusts are investment companies that trade in the same way as other listed companies;
- Share price is determined by the supply and demand and not the underlying asset. Therefore, they can trade on a discount or premium to their NAV;
- Investment trusts can use gearing in order to enhance their return;
- They have a closed-ended structure and fixed number of shares, which gives the manager more flexibility to build the portfolio with a long-term perspective;
- Investment trusts offer a range of benefits, one of which is the opportunity to invest in relatively illiquid asset classes such as physical property or private equity; and
- They have a board of directors, publish annual reports and conduct annual general meetings.
Unlike mutual funds that are typically priced once a day, investment trusts trade just like publicly listed companies, and investors could buy or sell shares at any point during market hours. The number of shares is fixed and the share price is driven by supply and demand. As a result of that, investment trusts can trade on a discount or premium to their Net Asset Value (NAV) – the value of the underlying holdings in the portfolio.
In addition, they can use gearing – borrowing more money to invest. This can magnify returns for shareholders in a rising market, but may also lead to greater losses during declining markets.
The Advantages of Investment Trusts
There are some specific features that investors can benefit from when investing in an investment trust. Once invested, they become shareholders of the company which means having a say on how the company is run through voting rights.
Due to their collective nature, even a small investment gives the investor exposure to a diverse portfolio of assets. Furthermore, the closed-ended structure gives investors the comfort of not worrying about liquidity issues. For example, there are asset classes such as physical property where daily liquidity is very difficult to achieve and mutual fund closures are not uncommon during periods of market volatility. Other relatively illiquid areas of the market that investors can access through investment trusts include small-cap stocks and private equity.
In addition, unlike mutual funds, they are allowed to retain up to 15% of their dividend income in reserve each year, which can be used to support income payments in future years. This is known as smoothing and offers investors more predictability.