Investment Trusts

An open ended fund creates new units when people buy and cancels them when people sell, so the manager takes money in and pays money out as investors come and go. An investment trust does not work that way. The number of shares is broadly fixed, so when you sell, your shares pass to another buyer rather than the manager having to raise cash.

The manager therefore never has to sell holdings at an awkward moment to meet redemptions. That makes the structure well suited to assets which take time to sell, such as commercial property, infrastructure, renewable energy projects and stakes in private companies. It is one of the few ways a private investor can hold that sort of thing in a form that trades daily.

Because the shares trade on the open market, the price is set by supply and demand rather than by the value of the underlying portfolio. That underlying value per share is the net asset value, or NAV.

When the share price sits below NAV, the trust is trading at a discount and you are buying the assets for less than they are worth on paper. When it sits above, that is a premium. Discounts widen and narrow with sentiment, which adds a layer of movement on top of how the portfolio itself performs. Buying at a wide discount can work in your favour if it narrows. It can equally get wider, and you can lose money on a trust whose portfolio has done perfectly well.

Investment trusts are allowed to borrow, which is known as gearing. A trust that borrows and invests the proceeds will do better than an ungeared one when markets rise and worse when they fall. Gearing magnifies the result in both directions, and it is the main structural risk that sets trusts apart from open ended funds.

Some trusts use it steadily, some tactically, some not at all. The level is published, and it is one of the first things worth checking, because two trusts holding similar assets can give quite different experiences depending on how much borrowing sits behind them.

A trust can hold back part of the income it receives in a good year and pay it out in a lean one. Open ended funds have to distribute what they earn. This is why a number of investment trusts have raised their dividend every year for decades, through recessions and market falls, and why they are popular with people drawing an income.

Smoothing is not a guarantee. Reserves can be run down, and a board can cut a dividend when it judges the income behind it is not coming back.

You buy and sell investment trust shares through a stockbroker or an investment platform, so there is usually a dealing charge each time and a spread between the buying and the selling price. The trust also has its own ongoing charges, and a few levy a performance fee on top. Smaller trusts can trade thinly, which widens the spread and makes larger deals harder to place.

Shares can be held inside a stocks and shares ISA or a pension, in which case dividends and gains are sheltered. Held outside a wrapper, dividends and capital gains are taxable in the ordinary way.

We use investment trusts where the structure earns its place. That usually means long term holdings, or exposure to assets which do not sit comfortably in a daily dealing open ended fund. For someone who may need the money at short notice, or who would be unsettled by a discount moving against them while the portfolio itself is fine, an open ended fund is often the better answer.

Heritage has been advising families across Somerset and the South West from our office in Taunton since 2000. We are independent and directly authorised by the Financial Conduct Authority under firm reference 624976, so we can recommend a trust, a fund, or neither, on its merits rather than because it is what we happen to sell.