Why use investment trusts?

Investment trusts are companies which are listed on the London Stock Exchange, and which invest in the shares of other companies. They can also hold other assets such as property and cash. They are run by boards of directors who appoint professionals to manage the underlying investments – known as fund, or investment, managers.

Investment trusts are known as ‘closed-ended’ funds because they have a finite number of shares in circulation. Unit trusts and OEICs on the other hand are ‘open-ended’ as they issue new units/shares when new investors wish to buy them.

When you invest money in an investment trust, the value of your holding is determined by the share price of the trust. The share price reflects the demand for the shares and is related to the value of its underlying holdings. If the trust’s own investments perform well, its shares will tend to rise in value as more investors want to buy them.

This means that an investment trust can have two different values – the value of its underlying assets minus its liabilities, also known as its Net Asset Value, or NAV; and the actual market price of its shares. These two figures are rarely the same. When the shares are worth less than the assets, the trust is said to be trading at a discount. When the shares are worth more, it is trading at a premium.

Many investment trusts currently trade at a discount, for example, if you buy shares at 90p, but the NAV is 100p, the discount is 10%.

You can see quickly whether you are buying the shares cheaply by finding out if the share price is higher or lower than the NAV per share. But remember, this principle also applies when selling shares!

The price of shares is published every day on the internet – usually on the managers’ website or see www.londonstockexchange.com – and in the financial press, for example in the Financial Times.

You can also compare investment trusts and look up NAVs and discounts or premiums at www.theaic.co.uk or at www.trustnet.com

There are 194 conventional investment trust companies managing a total of over £57 billion of assets. (Source: Association of Investment Companies, July 2008.)

Each investment trust has its own investment ‘objective’, which dictates the sort of companies it invests in. The investment manager of the trust must adhere to the remit by buying shares in specific companies. If it is a global trust, for example, the investment manager would buy shares in companies from around the world; if it is a US trust, he or she buys shares primarily in American companies.

Investment managers choose the companies they invest in after assessing their management, earnings, financial strength, share price, and the industries and economies they operate in.

As companies themselves, investment trusts are overseen by boards of directors whose main responsibility is to look after the interests of the shareholders. The directors appoint an investment manager to run the underlying funds, and make sure that the investment manager is competent and does not levy unreasonable charges.

Investment trusts have charging structures, covering administrative costs, as well as management fees paid to the investment manager. These costs are borne by the investment trust and will affect the performance of the underlying funds. One way to compare the cost of investment trusts is to look at the ‘Total Expense Ratio’, which can be found in the trust’s annual report and accounts.

When an investment trust itself sells shares it is not taxed on any capital gains it has made. In contrast, private investors may be subject to capital gains tax when they sell shares in their own portfolio, including shares in an investment trust.

There is no annual limit to the amount you can invest in investment trusts through a children’s investment plan. Therefore, if you receive financial gifts for your child, you know you can always invest them straightaway.

Furthermore, unless held in a bare trust, you retain control of the investment so you decide when your child should receive the proceeds, and whether they should have it all at once, or in stages. You do not have to make any of these decisions in advance – you can sell your shares in an investment trust whenever you like. This also means you do not run the risk of being forced to cash in your investment at a time when the stock market is doing badly. More information on bare trusts can be found under the ‘Setting up a bare trust’ section.

Investment trusts tend to have lower expenses than other forms of pooled fund. Unit trusts and open-ended investment companies (OEICs) usually levy initial charges of between 3 per cent and 5.5 per cent, as well as annual management charges often around 1.5 per cent. Any annual investment trust management and/or administrative fee will usually be lower than the annual fee for other forms of pooled fund (see also ‘How do investment trusts work?’ section). You will have to pay 0.5 per cent stamp duty on the purchase of shares in investment trusts and may pay commission if you buy through a stockbroker. If you buy investment trusts through a manager’s savings scheme, commission is usually not charged but there may be administrative charges for switching between investment trusts within, or selling from, a children’s investment plan.

Children’s investment plans vary from manager to manager so it is important to ask about charges and other costs before you invest.

The Association of Investment Companies, the investment trust trade body, defines 44 different categories of investment trust. The largest category is Global Growth, covering 36 trusts, with over £17 billion under management as at 31 July 2008, which invest all over the world.

Other categories range from specialist sector or country trusts to more complex trusts such as hedge funds and venture capital trusts. Some examples are:

– Specialist trusts
Specialist trusts are limited to investing in one industry or geographical area and tend to be riskier than global trusts or those which can invest across any industry. That is because they are generally focused on a single market, with less diversification to reduce risks.

– Growth and income trusts
Some investment trusts aim for capital growth, while others focus on generating income by investing in companies which pay good dividends to shareholders. Others balance both.

For more information about the different types of trust you can invest in, see the AIC website at www.theaic.co.uk which lists details of their members’ trusts.

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