As stock market listed companies, investment trusts have independent boards to represent the needs of investors.
Investment trusts having boards mean investors in this product get the same level of protection as company shareholders.
Robin Stoakley, managing director for UK intermediary at Schroders, says investment trusts stand out because of strong corporate governance.
He says: “Investment trusts are governed by an independent board that represents investor interests.
“The board of directors are responsible for appointing the fund manager, managing the discount or premium in the shares, dividend policy, negotiating management fees and deciding gearing policy.
“They act independently of the manager.”
The trust structure also offers the benefits of a fixed pool of capital, Mr Stoakley notes.
Unlike open-ended funds, which are typically daily traded, Mr Stoakley says investment trust managers do not have to worry as much about how liquid their portfolio of investments is.
This is because investors buy and sell shares on the stock exchange independently of the pool of capital being managed.
As such, Mr Stoakley says investment trusts can hold more illiquid assets for a long period of time and these can often be very attractive investments.
Typically he says this means they can hold larger positions in assets like smaller companies and illiquid real assets like property and infrastructure.
Investment trusts can borrow money (gearing) so that they can increase their market exposure and therefore potentially enhance returns.
However, gearing can also increase the potential for losses when markets fall, so it is important to check how gearing is used in an individual trust.
The net asset value (NAV) is the combined value of all the assets the trusts hold.
Unlike other investment funds, shares in an investment trust can be bought and sold at a price that is higher or lower than NAV.
So it is possible to buy shares in an investment trust at a lower price than the value of the underlying assets.
It all comes down to market demand.
If the share price is less than the NAV the shares are said to be trading at a discount.
However, when the share price is higher than the NAV, the shares are trading at a premium.
Schroders’ Mr Stoakley says investment trusts are also able to keep up to 15 per cent of the revenue they receive from their underlying investments in a reserve.
He says this is useful because if a reserve is built up over time and there is a cut in the income the company receives from its investments, the board can use the reserve to ensure that there is not a dividend cut.
Mr Stoakley says: “This is known as dividend smoothing and this can be beneficial for investors seeking security of income.”
In summary the main features of an investment trust are;
1) Investment trusts are closed-ended: an investment trust has a fixed number of shares.
The fund manager can invest and sell assets when they feel the time is right; not when investors join or leave a fund. It also means the underlying capital investment base is relatively stable.
2) Borrowing powers: investment trusts can borrow money (known as gearing) to take advantage of investment opportunities.
Borrowing can increase the returns for shareholders, but if the assets fall in value, it can also increase the potential for losses.
3) Income: investment trusts can retain up to 15 per cent of their income in any year. This can be used to supplement income in future years.
4) Governance: every investment trust has an independent board of directors. They are responsible for safeguarding shareholder interests. Investors have shareholder rights: when you invest in an investment trust you become a shareholder in that company.
This gives you the right to vote on issues such as the appointment of directors or changes to the investment policy.
James Budden, director at Baillie Gifford, says another key feature for advisers to consider is costs can be lower than with Oeics, especially for the big trusts plus managers can keep back income to build up reserves.
