An investment trust is a collective investment. It includes a number of different individual investments that are selected and handled by an investment manager. However, compared to other types of collective investments, like OEICs or unit trusts, they provide several different unique features.

Investment trusts first emerged during the 1860s, and are the oldest type of collective investment by far. Despite their name, they are actually not trusts. Instead, they are companies that are listed on Stock Exchanges. In order to invest in one, you purchase shares. Their prices are determined by both supply and demand as well as the underlying assets’ value.

For some investors, those differences can make investment trusts more attractive. They believe they will be able to outperform other types of funds. However, investments also can be more volatile since they trade at a discount or premium to their net asset value and gearing can be used. Before investing, keep in mind that prices may fluctuate and that you can lose money in addition to earning a profit.

Investment Trust Key Features

Portfolio diversification – exposure is offered by investment trusts to a number of different assets with a single investment. For example, take a look at this Henderson Smaller Companies share price to get an idea of the movement and also the different companies in a trust.

Expert management – the investment management team of the trust makes the daily decisions. Investment trusts are publicly traded companies, so there is a board that represents shareholder interests. 

Choice – choose from more than 450 investment trusts that span all specialist and mainstream sectors as well as all of the major geographical areas. Or you can use our Investment Trust list to narrow the field.

Trade on Stock Exchanges – an investment trust trades in the exact same manner as individual company shares do. At all times of the day, you can see what their price is and deal whenever the market is open.

Possible higher risks and rewards – investment trusts trade at either a premium or discount and frequently borrow money in order to invest, which is referred to as gearing. That means it is possible to increase your returns. However, on the other hand, your losses can also be amplified

Before investing in an investment trust, it is critical that you understand the two major ways that they are different from other collective investment types such as ETFs and funds.

Discounts and premiums

The total amount of the holdings of an investment trust, less any liabilities, is referred to as the net asset value (NAV). A key thing that needs to be understood about investment trusts is you can purchase them for more (at a premium) or for less (at a discount) than what their NAV is.

This feature may appear to be confusing. However, it occurs because an investment trust is set up as a company and is independently traded on the London Stock Exchange. Just like other types of listed companies, the share value will be based on market sentiment- what investors believe their worth is.

For example, assume an investment trust has a £1 per share NAV. If it was trading for 95p per share, then you could purchase it at a 5% discount of NAV. On the other hand, if it is trading at  £1.08 per share, then you would need to buy it at an 8% premium – paying more than its underlying assets’ value.

Purchasing investment trust shares at a discount is frequently considered to be a great investment opportunity. However, it is not actually that simple. Investment trusts may trade at a discount for a number of different reasons.

Low confidence in the management of the trust

The trust that the sector belongs to is out of favor or is struggling

Fear of high liquidation expenses if the trust needed to wind up, sell its asset off, and return the proceeds to its shareholders

Investment trusts rarely trade at a premium. Whenever they do, usually it is due to the investment manager’s expertise. However, before you invest in a trust that is trading at a premium, exercising caution is a very good idea.

You can determine the NAV and discount or premium for each investment trust on our website on its research page. Keep in mind that investment trusts have been designed as long-term investments to be held for five years or longer.

Gearing

Another major difference between investment trusts and other funds is that investment trusts are able to borrow money for investing. It is referred to as gearing.

Say that £100 million is raised from investors by a trust and it borrows £10 million from a bank, which means the total investment is £110 million. So the trust, in this case, is 10% geared.

If the trust is able to earn a higher return on the borrowed money than the amount of interest that is being paid on the loan, then gearing is beneficial for the shareholders and helps to increase overall returns. When the markets go up, the geared trust share price will increase faster.

However, when markets drop, the shares in a geared trust will fall further and be very alarming. Over short time periods, gearing can cause investment trusts to be higher risk and the shares more volatile compared to other types of investments.

However, there are strict limits on the amount of gearing that can be used by an investment Is common for the maximum to be at 25% to 30%. However, a majority of trusts do not go that high in practice.

All of the above information should help you when selecting a good trust that fits your needs.