InvestmentsAug 19 2014

Everything you need to know about investment trusts

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      CPD
      Approx.40min
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      CPD
      Approx.40min

      Back in 1896, the first investment trust was launched with the objective of giving the small capitalist the same advantages as the large capitalist.

      And so the great idea of pooling small sums of money together to invest began in the UK. (The Dutch were the first with a collective investment scheme, for tulip investment.)

      In a post-Retail Distribution Review world, many are looking to investment trust companies as suitable low-cost investment schemes, as well as valuable portfolio constituents.

      What they are

      An investment trust is a company that is set up solely for investment. This is typically to invest in the securities of other companies, but it could also be to invest in real assets like property or infrastructure projects.

      The term ‘trust’ is actually a misnomer, and in the US and Australia they are called investment companies. However, in the UK investment companies can own the mandates of several funds, which may include unit trusts and Oeics. The defining characteristic of an investment trust relative to the latter type of funds is that it is a closed-ended structure.

      That means that the fund size is fixed by the number of shares. If investors in the fund want to withdraw, either wholly or in part, then they have to sell their shares on the stock exchange that they are quoted on. This is in contrast to the open-ended structures of unit trusts and OEICs, which allow them to create new units or cancel existing ones.

      Discounts and premiums

      Since the number of shares in an investment trust does not change when investors buy and sell them, the price per share is determined by supply and demand, and may not be the same as the net asset value of the underlying holdings. This is an important difference from open-ended structures in which the units’ price should always equal the Nav.

      When an investment trust’s share price is higher than Nav it is described as trading at a premium, and may reflect investors’ confidence in the ability of a portfolio manager to outperform. One view of why investment trusts on average seem to trade at a discount to Nav is because of charges, which can over time outweigh any added value by managers.

      Overall it is the stock market valuation that has an effect. In bull markets, the average discount to Nav of investment trusts normally narrows and conversely in bear markets it widens. It follows that the ‘goldilocks’ scenario is to overweight investment trusts at the initial period of a market recovery phase, ensuring the double whammy of positive returns and discount narrowing.

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