In performance terms, the attraction of investment trusts is consistently evident. They allow you to pool your money with that of other investors to get exposure to a range of assets through a single investment and are listed companies that issue a fixed number of shares quoted on a stock market, such as the London Stock Exchange.
Best kept secret of the investment world
Investment trusts have been around since the 1860s and they have long been regarded by many as the best kept secret of the investment world. They are 'closed-ended' investments, meaning they issue a fixed number of shares when they are set up, which investors can then buy and sell on the stock market.
Investment trust managers always have a fixed amount of money at their disposal, and won't have to buy and sell to meet consumer demand for shares. This can add a degree of stability to investment trust management that a unit trust manager won't have.
Spreading investment risk
The diversity investment trusts offer means you can spread risk by investing in tens or even hundreds of companies through one investment. However, this doesn't mean there is no risk to your capital, and the risks will vary depending on where the trust invests.
Due to changes in the value of the assets the investment trust owns, supply and demand can fall out of line. As such, there is a chance that the trust's share price could trade at a discount to the value of its underlying assets, or even trade at a premium.
Supply and demand in the stock market
The value of the assets held by an investment trust is called the 'net asset value' (NAV), usually expressed as pence per share. If a trust has £1million worth of assets and one million shares, the NAV is 100p. However, the price of an investment trust's shares is determined by supply and demand in the stock market. This means the price you pay will almost invariably differ from the NAV.
If a trust is trading at less than its NAV, it is said to be trading at a discount. If the share price is higher than the NAV, it is trading at a premium. Often, investment trusts trade at a discount. This looks like good value, as you pay less than £100 for £100 worth of assets. However, there is no guarantee that any discount will have narrowed by the time you come to sell. If the discount widens, then you'll lose out in relative terms, whatever happens to the NAV of the trust.
Borrowing extra
money to invest
Investment trusts also have the advantage of being able to borrow extra money to invest (known as 'gearing'). This ensures a boost in returns when the stock markets are performing well. As such, since share prices have historically tended to increase over the longer term, gearing has proved to be beneficial with regards to investment trusts, albeit adding risk at the same time. However, when share prices fall, the losses of geared funds are multiplied.
INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.
THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.
PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.
