What is an Investment Trust in the UK?

An investment trust is a type of company listed on the stock exchange. It pools money from investors to invest in a diversified portfolio of assets. These trusts are structured as public limited companies and are managed by professional fund managers. Investors who purchase shares become part-owners of the trust.

Note that investment trusts have a long history in the UK, dating back to the 19th century. They are widely considered a reliable option for long-term investors. Unlike open-ended funds, investment trusts are “closed-ended.” This means they issue a fixed number of shares when they are launched. Their structures allow fund managers to focus on long-term performance. This is without worrying about inflows and outflows of capital, which can destabilise open-ended funds.

How Do Investment Trusts Work?

Investment trusts function by pooling money from investors and using it to buy a diversified portfolio of assets. These trusts are governed by a board of directors. They oversee the fund’s management and ensure it aligns with shareholders’ interests. Fund managers make day-to-day decisions on which assets to buy or sell. Their decisions are guided by the trust’s stated investment objectives.

These trusts trade on the stock exchange. During the day, the share prices move with the supply and demand. The share price of an investment trust differs from that of the NAV. Consequently, it leads to shares trading at either a premium above NAV or a discount below NAV.

Another important characteristic of investment UK trusts is that they can “gear” or borrow money to invest. Gearing can magnify returns if investments rise but also amplifies losses when markets fall. This makes gearing a two-edged sword that has to be considered with due care.

Types of Investment Trusts

There are thousands of investment trusts in the UK financial landscape. They are categorised in a variety of forms, including:

1. Equity Investment Trusts

Equity investment trusts usually invest in the shares of publicly listed companies. These sorts of trusts are ideal for investors seeking capital growth, as they invest in equity markets that have generally provided superior returns over the long term. Some may specialise in particular regions, industries, or approaches to investment styles, like growth or value investing. For example, the Scottish Mortgage Investment Trust. It is a well-known equity trust that invests in innovative global companies, such as Tesla, Amazon, and Moderna. 

2. Fixed-Income Investment Trusts

Fixed-income investment trusts invest in bonds and other debt instruments, mainly to generate regular income. These are ideal for the conservative investor who would rather have income stability instead of capital appreciation. The bonds in these trusts can range from government-issued securities to corporate bonds, carrying different risks and returns. For example, the Henderson Diversified Income Trust invests in a diversified portfolio. It focuses on corporate bonds, high-yield debt, and other fixed-income assets. 

3. Multi-Asset Investment Trusts

Investment trusts falling under this category invest for diversification. They focus on a mix of asset classes such as equity, bonds, property, and commodities. As a matter of fact, multi-asset trusts are suitable for any investor who needs to make moderate growth over reduced volatility. The best thing about it is that the fund managers can alter the allocations with the prevailing market conditions. This will help the fund to ride through various economic cycles. Monks is a notable multi-asset investment trust that aims to protect capital and deliver steady growth. 

4. Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts specialise in property investments. These trusts either own physical properties, such as commercial or residential real estate, or invest in property-related securities. REITs are known for their high dividend payouts, as they are required to distribute at least 90% of their taxable income to shareholders. They are an attractive option for income-focused investors. A good example of REITs is the Land Securities Group (Landsec). It focuses on commercial properties, including shopping centres and office buildings. Another example is the Residential Secure Income Trust, which invests in residential properties, offering exposure to the housing market.

5. Venture Capital Trusts (VCTs)

Venture Capital Trusts invest in small, early-stage companies with high growth potential. These trusts are designed to encourage investment in startups and smaller businesses by offering significant tax advantages, such as income tax relief and tax-free dividends. However, VCTs carry higher risks due to the volatile nature of startups and are best suited for experienced investors with a high-risk tolerance. An excellent example of a VCT is the Baronsmead Venture Trust. It supports innovative startups in sectors like technology and life sciences. These investments are inherently riskier but can yield substantial returns if the companies succeed.

Pros and Cons of Investment Trusts

Before venturing into investment trusts in the UK, understanding the pros and cons attached is crucial. These include:

Pros

• Investors are shareholders: Investment trust shareholders are part-owners of the company they invest in. This ownership structure aligns the interests of the investors with the trust’s management and governance.
• Closed-end structure: The fixed number of shares in an investment trust allows fund managers to focus on long-term investments. This is without the pressure of handling cash inflows and outflows, which can destabilize open-ended funds.
• Easy to track: As publicly listed companies, investment trusts are easy to monitor. Share prices, performance reports, and financial statements are readily available on stock exchanges and company websites.
• Investor protection: These trusts offer secure investment opportunities. They are subject to regulations by the Financial Conduct Authority (FCA), thus ensuring high levels of transparency and investor protection.
• Variety of investment options: They offer investors with an already established portfolio. These portfolios are managed by professionals and you get to spread risks across several companies.
• Gearing: The ability to borrow money can enhance returns during market upswings. This gives investment trusts a potential performance edge over open-ended funds.
• Smoothing income: Many investment trusts in the UK offer a reliable income stream. Investors can reserve a portion of their income in profitable years to maintain steady dividend payouts during lean periods. This makes them attractive to income-focused investors.

Cons

• Premiums and discounts: Share prices can deviate from net asset value NAV. This means investors may pay more or receive less than the trust’s underlying value.
• Liquidity and costs: Fixed share supply often results in lower liquidity, higher trading costs, and wider bid-ask spreads.
• Gearing: While this element can bring about profits, it can also amplify losses in falling markets. This can make investment trusts more volatile than their fund peers. 

How to Invest in Investment Trusts

Investing in investment trusts UK is straightforward. However, it requires research and planning. Here are the steps:

How to Choose the Right Investment Trust

Investors in the UK should choose investment trusts they are familiar with and that fit their risk tolerance and financial goals. Here are the top elements to consider in your research.

Conclusion

Now that you know what an investment trust is and the available types for UK investors, you can try a few options. Before you do, conduct extensive market research for suitable options. This is because the market hosts thousands of investment trusts. You want to venture into a security you are familiar with and are guaranteed good returns. 

Overall, investing in these funds carries risks, and there is no profit guarantee. Do not put up your money in a fund without a solid strategy. Plus, keep track of your investments and only risk funds you are comfortable losing. By remaining disciplined, investing with a suitable broker, and being open to learning from your mistakes. In this case, you will see yourself gradually improving your approach and becoming more independent.