Investment Income CPD Course  

An exploration of investment trusts and client suitability

  • Explain why investment trusts may be suitable for certain clients.
  • Describe key elements of investment trusts and how they work.
  • Understand how they can be used effectively to augment certain client portfolios.
An exploration of investment trusts and client suitability
Artem Podrez via Pexels

Suitability is at the heart of selecting investments for a client. That is not just because the Financial Conduct Authority says so, but because it is self-evidently right.

Where investment trusts fit in, or if they fit in, to a client’s portfolio should also be considered with suitability in mind.  

That may sound obvious, but research conducted by Research in Finance for the Association of Investment Companies found that the reasons many advisers do not consider investment trusts for clients do not have much to do with suitability. 

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Instead, key reasons include some advisers’ lack of knowledge around features of investment trusts such as discounts and gearing, inertia and a raft of fairly technical concerns about platforms, the availability of ratings and the like.

Yet advisers who do recommend investment trusts – more than 1,500 businesses in the first quarter of this year – successfully overcome these perceived barriers.

This article aims to step back from these concerns, and look at the bigger picture of when investment trusts might be suitable for a client. We will also look at the risks of investment trusts and how these might impact suitability. 

Investment trusts as retail investment products

The FCA considers securities in investment trusts to be retail investment products, on a par with life policies, OEICs or unit trusts, pension schemes and structured investments. 

According to the FCA, independent financial advisers are supposed to “consider and recommend a wide range of retail investment products” that could meet clients’ needs and objectives. 

This places investment trusts firmly within the IFA’s remit.

So when might investment trusts be suitable for a client? 

There are three key reasons to consider an investment trust over an open-ended fund. One of them is to do with income, and applies particularly to advisers using natural income strategies for clients – amounting to 34 per cent of all advisers, according to research for the AIC by The Lang Cat.

The second reason is to do with performance, and the third is to do with accessing less liquid assets. 

Suitability for income investors

Beginning with income, investment trusts are able to reserve up to 15 per cent of the income they receive from their portfolio each year. 

This income goes into a 'revenue reserve', which is available for paying out dividends in future years. 

The revenue reserve is not a pot of cash, it is part of the investment trust’s assets and can be fully invested. It is simply a line in the investment trust’s accounts representing income that has not been paid out yet.

By holding back some income in good years to pay out in leaner ones, some investment trusts have built up long track records of increasing their dividends every year.

So-called 'dividend hero' investment trusts have increased dividends for at least 20 years in a row. The City of London Investment Trust, which invests in UK equities, just notched up 55 consecutive years of dividend increases. Its current yield is 4.8 per cent.