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Investment companies compared to other funds

This article is part of
Guide to Investment Trusts

Investment companies differ from open-ended funds as they are stand-alone listed companies in their own right, meaning for example the cost of investing is based on a share price.

Like most public companies, the share price is usually affected by market sentiment and is different to the value of the company’s net assets, adding an extra layer of volatility. If the share price is more than the NAV then the trust is said to be trading at a ‘premium’, and if it is lower than NAV it is trading at a ‘discount’.

Investment trusts also have an independent board of directors to represent shareholder interests. The board can play an important role in terms of charges, setting and reviewing investment policy, and scrutinising the performance of the fund manager, says Annabel Brodie-Smith, communications director at the AIC.

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In extreme cases, the board of an IT might choose to sack the manager and move the management to a different group.

As a shareholder in an investment trust, investors can vote on key issues, request resolutions and attend the annual general meeting.

As investment trusts are a fixed pool of capital, they are closed-ended and unlike open-ended vehicles they cannot issue new shares, redeem them or ‘buy back’ on demand, whereas open-ended funds expand and contract depending on whether money is coming into or out of the fund.

Says Stephen Peters, investment trust analyst at Charles Stanley: “ITs can issue shares in certain circumstances and if they do so, they will do so at the same level as NAV, or slightly above.

“A trust might issue new shares to increase supply if it was trading at a premium, because it is unattractive to many investors to buy £1 of assets for more than £1.”

The fixed size of the capital can be advantageous for IT fund managers and was a chief reason why Anthony Bolton runs his China Special Situations as a trust.

Says Ms Brodie-Smith: “It means they can take a long term view of the market without having to worry about fluctuations in the size of the fund, and they do not have to worry about being forced sellers to meet redemptions.”

This can be especially useful when it comes to more illiquid sectors such as property, private equity or infrastructure.

The structure of investment trusts also means fund managers can use leverage or gearing, meaning they can borrow money and invest it with the hope that returns exceed the cost of borrowing.

“Gearing is a reason which has helped the sector outperform other types of collective investment over the longer-term, but it can add risk as gearing boosts performance both on the upside and the downside,” states Ms Brodie-Smith.

Not all ITs gear and the average gearing across the industry is quite modest at around 7 per cent.