You may never have heard of investment trusts, but there are 349 of them and more than £265 billion invested in them. How do they work?
If you’ve got some money invested (as opposed to savings in the bank), the chances are that it might be in a pension, or perhaps a stocks and shares individual savings account (ISA).
Most stocks and shares ISAs invest in pooled funds, rather than in shares of individual companies. But there’s a way you can combine the two by putting money into an investment trust. Here’s what you need to know.
What is an investment trust?
Shares in investment trusts are traded on the stock market just like any other share. The big difference is that investment companies buy shares in lots of other companies, which means your money is spread around. This makes it less risky than investing in a single company alone, although there are still no guarantees that you won’t lose money.
The basic principle behind an investment trust is relatively straightforward. It’s the jargon that’s off-putting – so bear with us.
- An investment trust buys different types of shares, bonds or commercial property or whatever the ‘asset’ is that the investment trust has chosen to invest in. If it invests in shares, it will buy shares in dozens of different companies, if it’s commercial property, it will invest in different office blocks, factories and/or retail developments.
If you want to put money into an investment trust that invests in shares, there are lots of factors that can influence the amount of risk you’re taking on. One will be how widely it spreads investors’ money between different companies. If you have two identical investment trusts, the only difference being that one invests in 50 companies and the other in 10, the one that invests in 50 companies should be less risky.
- An investment trust is ‘closed-ended’: This means that only a fixed number of shares are issued and the number of shares remains the same. Unit trusts and open-ended investment companies (OEICs) are different because they can issue more ‘units’ if they become very popular, to cope with the demand, and can cancel them if there are fewer investors. This can make investment trusts more volatile as the share price will vary according to whether or not a particular investment trust is popular with investors.
When you invest in an investment trust, your money is managed by a professional fund manager. They decide which investments to buy and which to sell (and when to do it). Part of the money you invest is used to pay the fund manager’s fees.
Fans of investment trusts like the fact that the fees you pay every year (they’re called ‘annual management fees and they’re taken directly from your regular or monthly payments) are generally a lot lower for investment trusts than for the more popular form of pooled funds, which are unit trusts and OEICS.
What makes investment trusts different to unit trusts and OEICs?
Although investment trusts may appear similar to unit trusts and OEICS, there are some major differences.
One of the main differences is that investment trusts can borrow against their value, whereas unit trusts and OEICs can’t. This is known as ‘gearing’ and the principle is the same as taking out a mortgage. Instead of borrowing against the value of property, investment trusts borrow against the value of the assets (such as shares in companies) that they already own.
Gearing is great if you’re making money, because it magnifies the gains, but it also increases the losses. Say an investment trust has £100 million, of which £20 million is borrowed and £80 million is investors’ money. If it falls in value by £20 million, investors’ money loses 25% (£20 million is 25% of £80 million), even though the overall fund has only fallen by 20%.
Another major difference between investment trusts and other collective investments is that investment trusts can trade at a discount or premium. So, in the same way that the share price of high street companies fluctuates on the stock market, so can the value of shares in investment companies (which set up the investment trusts).
If an investment trust is trading at a premium, it means the shares can be worth more than the money invested in it. If it trades at a discount, the shares are worth less.
If you want personal recommendations about where to invest your retirement savings, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedFor* or Unbiased*, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
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