What is an Investment Trust? How Do They Compare to Funds? - NerdWallet UK (2024)

Investment trusts, also known as a closed-ended fund, are often called ‘the city’s best-kept secret’. Still, they are often overshadowed by the open-ended investment companies (OEICs) and unit trusts they routinely outperform.

What is an investment trust?

Investment trusts are companies listed on the stock exchange that sell shares to investors and then pool that money together to make carefully selected investments in bonds, property, shares and other assets on behalf of its shareholders.

How investment trusts work

Investment trusts are led by an independent board of directors who are elected to represent shareholder interests. It is their job to set policies and hire a fund manager from an asset management firm who will be responsible for picking the best investments and ensuring that shareholders get value for money.

Like other collective investments, each trust has a specific mandate or objective. The Association of Investment Companies (AIC), the industry’s trade body, categorises trusts by sector, usually based on which region, industry or type of investment they pursue.

Some have a broad remit, targeting all companies in the world with the greatest potential to grow in value. Others are more niche, with a more focused remit, such as domestic dividend payers, small companies, healthcare, property or ethical and sustainable initiatives.

The type of investment a trust chooses, and how it is pursued, is important in determining how risky the investment might be.

How do investment trusts differ from funds?

Investment trusts have been around since the Victorian era and are highly regarded by finance professionals. A stellar long-term track record and glowing endorsem*nts from industry insiders, however, still haven’t catapulted them into the mainstream.

Part of the reason they are overlooked is down to choice – there are fewer than 400 investment trusts compared to the thousands of funds, such as unit trusts and OEICs. Trusts also have a reputation for being complex and difficult to understand.

Four features that make investment trusts stand out:

There are a set number of shares in circulation, meaning you may only invest when the trust is launched or if someone wants to sell. This close-ended policy gives trust managers freedom to pursue their objectives, without being pressured to add investments when new money flows in and offload them when investors decide to exit.

2. Freedom to borrow

Some trusts borrow money to buy bigger stakes in investments, known as gearing. This process can be both lucrative and dangerous because it amplifies gains when an investment performs well but accentuates losses when they fall.

3. Ability to trade at a discount and at a premium

Since investment trusts trade on a stock exchange, the share price depends on supply and demand, rather than the actual value of their combined holdings – known as net asset value (NAV).

Since the price is based on what investors think it is worth, instead of the NAV, the investment price can be undervalued or overvalued. Without demand, an investment trust is undervalued and will sell for less than its NAV, which is called trading at a discount. When a trust is in high demand, the trust is overvalued and its trade price can rise beyond its NAV, which is known as trading at a premium.

4. Regular cash flow for investors

Investment trusts can withhold up to 15% of income generated from their investments to deliver back to investors in the form of a dividend payout at a later date, such as when returns are down. This unconventional approach differs from open-ended funds that return all income to investors. It also means that investors should always get a stable or steadily increasing income, regardless of what is going on in the economy and in company boardrooms. This is a popular feature for investors who like dividend payouts.

How to invest in investment trusts

You can buy shares in an investment trust by purchasing them directly from the trust or by buying them on the secondary market from a broker or investment platform.

To purchase them directly from the trust, you will need to buy them from an investment trust that has recently launched.

To buy them on the secondary market, you will need to find willing sellers, which can be relatively easy. All you need is a broker, or an investment platform to act as your broker. These online fund supermarkets offer competitive pricing, lots of choice, and the option to invest tax-free by purchasing shares through an ISA.

Usually, you will have to pay platforms for any transactions you make, as well a fee to hold your investments with them – the AIC has put together a useful table to compare these charges.

How to choose an investment trust

Start by researching which investment trust best suits your needs. Establish your goals, consider what sector you want to invest in, and browse through the choices on the AIC website.

Once you have narrowed down your criteria, it is time to put together a shortlist. Important factors to think about include track records, if the trust is trading at a fair price, whether you want to make use of gearing, and any associated charges.

Aside from platform fees and other external costs, you will pay the trust an annual ongoing charge. This is deducted from your investment, expressed as a percentage, and covers its day-to-day running expenses.

The key for investors is to figure out if the fees are justifiable, given the job the trust has been tasked with, and whether prospective returns, after factoring in charges, will be high enough to leave you with more money than you could reasonably make elsewhere.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

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