Investment Trusts  

Why investment trusts are riding high

  • To understand the basics of investment trusts.
  • To be able to list the differences between investment trusts and open-ended funds.
  • To ascertain how to advise clients on investment trusts.
Why investment trusts are riding high

Investment trusts are enjoying a renaissance.

Industry assets stand near a record high at £174bn. The average discount to net asset value (NAV), an index of trusts’ popularity, is extremely narrow by historical standards.

Moreover, purchases on adviser platforms have increased fivefold since before RDR, to £948m in the year to October 2017, according to Matrix Financial Clarity. 

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Yet, despite all this, the majority of advisers still make no use of investment trusts in clients’ portfolios. Among the reasons given is a perceived need among advisers to improve their knowledge of the structure, along with the practical implications of using investment trusts with clients. 

Differences from open-ended funds

Investment trusts are also known as closed-ended funds. They’re ‘funds’ because they are diversified portfolios of assets, just like Oeics or unit trusts.

But unlike Oeics and unit trusts, they are ‘closed-ended’, having a limited number of shares in issue that are traded between investors on the stock market. We’ll return to this ‘closed-ended’ nature of investment trusts later; it is absolutely key to understanding them. 

An investment trust takes the legal form of a company (not a trust). That’s why investment trusts are also known as investment companies. The investment trust has a board of directors, but usually no employees.

The directors typically outsource management of the trust’s portfolio of investments to an asset manager. So, for example, the Edinburgh Investment Trust outsources investment management to Invesco Perpetual, and is managed by Invesco’s Mark Barnett. 

Importantly, the board is independent of the asset manager. So the Edinburgh Investment Trust could, in future, decide to outsource management to a different group – BlackRock or JPMorgan, for example – if the board felt (and shareholders agreed) that such a change would benefit performance. 

The two most important differences between an investment trust and an open-ended fund, such as an Oeic, are discount/premium pricing and gearing. 

Discounts and premiums arise because the investment trust’s shares are traded on the stock market: this is how investors buy or sell. But the share price is often different from the underlying value of assets within the investment trust, what’s called the net asset value (NAV). 

Let’s say an investment trust has net assets of £100m (note that this could be £110m of assets and £10m of borrowings, for example). It also has 100m shares in issue. This means every share has an NAV of 100p. 

If the share price were 95p, we would say the investment trust traded at a 5 per cent discount. If the share price was 103p, it would be trading at a 3 per cent premium.