What is an investment trust?

An easy explanation of these exciting investment companies

1. An investment trust (IT) is essentially a company which invests in other companies. There are about 400 of them and some have been going for more than 50 years. Confusingly they are sometimes called investment companies too.

2. Like any other firm, the IT is run by a board of directors. They choose and hire a fund manager to invest the IT’s cash in shares or other investments to hopefully make lots of money.

3. So what do you get? Just as if you were buying shares in Tesco or Marks & Spencer, you buy shares in the company and become a shareholder. You can attend the annual general meeting and vote on issues such as who gets to be a director.

4. You can buy IT shares through an online stockbroker such as Hargreaves Lansdown, The Share Centre or maybe through your bank. Similar to Tesco shares, you can hold IT shares inside tax perk schemes such as Isas and pensions.

5. Being a company, an IT can do more things than your average investment fund (a unit trust or OEIC in the technical language) which has less freedom. But this can make ITs more risky too.

6. For example, ITs can borrow to invest whereas average funds can’t. This is great when the investment goes well because you boost your gain. But, if something goes wrong, the IT may end up with both the loss of the original stake as well as owing the loan. Ouch!

7. Share prices of an IT are more complicated too. They don’t always match the real worth of the IT’s investments (called the net asset value or NAV) and can move in line with whether investors want to buy them or not instead.

8. This plays out in the following way. IT shares sometimes trade at a premium to NAV – ie are more expensive than what’s on the inside. This usually happens because the IT is investing in a fashionable area or its manager is very popular. However, the reverse can also happen and the shares can trade at a discount. If you can time your buying and selling right, you could make a tidy gain over and above what the underlying investments themselves produce. But, again, the reverse is also true.

9. You will have to pay a dealing fee to buy (and sell) IT shares and some kind of annual charge to your online platform or wherever else you keep them. Don’t forget the IT itself also has management fees of usually a few percent of the (net asset) value of your investment.

10. There are many different types of IT in terms of structure and what they invest in. They range from international shares to property to risky start-up technology and healthcare companies. The two largest as of June 2018 are Scottish Mortgage on £7.7 billion and Foreign & Colonial on £3.8 billion. Both invest in global shares.

 

More stuff:

  • Find out lots more about ITs at the Association of Investment Companies
  • Research from finance firm AJ Bell on the most popular ITs is here
  • See news about ITs, current share prices and how they’ve performed at Trustnet here

Last updated 15 June 2018.