Understanding Investment Trusts
What is an Investment Trust?
At its core, an investment trust is a public company that raises capital by selling shares to investors. This capital is then pooled together to buy and sell various assets, primarily stocks. Think of it as a community potluck: everyone contributes, but the investment manager decides what goes on the table. This approach allows for diversification, which can reduce overall risk.
How They Operate
Unlike unit trusts, which are open-ended, investment trusts are closed-ended funds. This means they issue a fixed number of shares on the stock market. The price of these shares fluctuates based on supply and demand, as well as the trust’s underlying asset value.
The Role of Shareholders
When you buy shares in an investment trust, you’re becoming a part-owner of the trust’s assets. However, be mindful—if you want to sell your shares, you’ll need to find a buyer, often through the stock market. The trust’s manager doesn’t buy back shares unless the trust is winding up.
Types of Investment Trusts
Conventional Investment Trusts
Conventional investment trusts operate as public limited companies, allowing them to borrow money—also known as “gearing.” This aspect is key as it can enhance returns in a rising market, but it also heightens losses when the market declines.
Advantages of Conventional Trusts
- Diversification: These trusts typically invest in a variety of sectors, reducing risk.
- Gearing Opportunities: Smart borrowing can bolster returns.
Disadvantages of Conventional Trusts
- Increased Risk: With potential to amplify losses, gearing can be a double-edged sword.
- Trading Variability: Shares can trade below (discount) or above (premium) the underlying asset value, affecting perceived profits.
Split Capital Investment Trusts
These trusts have a fixed life, generally running from five to ten years. They issue different types of shares, prioritizing a specific order for payouts.
Structure and Function of Split Capital Trusts
Investors can choose from various share types. Typically, the farther down the payment order, the higher the risk and potential return. However, always consider market fluctuations—your returns aren’t guaranteed.
The Mechanics of Investing
Buying Shares in Investment Trusts
Purchasing shares in an investment trust is somewhat akin to buying stock in any public company. You’ll need to enter the stock market to make your buy, possibly using a brokerage platform.
Understanding Trading at a Discount or Premium
The price discrepancies—when shares trade below or above the net asset value (NAV)—can impact your gains. If shares trade at a discount, it might represent a buying opportunity. Conversely, if the premium widens, it could signal overvaluation.
Risk and Return
The Impact of Gearing on Investment Returns
Gearing, or borrowing, can magnify returns. For instance, if a trust uses borrowed funds to invest and the market performs well, the profits can be substantial. However, the opposite is also true—market declines can lead to significant losses.
Risk Assessment in Different Trust Types
Understanding the underlying assets within the trust is crucial. Whether they’re primarily equities, bonds, or alternative investments, each carries distinct risk levels. Make sure to thoroughly investigate the trust’s strategy before investing.
The Essentials of Tax Efficiency
Capital Gains Tax and Dividend Allowance
As of April 2024, individuals have access to a tax-free dividend allowance of £500. Any income from shares held in an ISA is also tax-free, making these investment vehicles particularly appealing.
Utilising ISAs for Tax Efficiency
Using an Individual Savings Account (ISA) can be a game-changer for minimising tax liabilities. By holding your investment trusts in an ISA, your dividends and capital gains will remain tax-efficient, boosting your overall returns.
Making Informed Investment Choices
Analysing Fund Performance
Always conduct thorough research before investing. Look at historical performance, fees, and the trust’s management style. Performance data from reliable financial platforms can help assess which trusts align with your investment goals.
Getting Professional Advice
If this feels daunting, consider enlisting a financial advisor. They can offer tailored advice based on your financial situation and help you navigate the ever-changing investment landscape.
The investments and services offered by us may not be suitable for all investors. If you have any doubts as to the merits of an investment, you should seek advice from an independent financial advisor.
You should be aware that certain types of funds might carry greater investment risk than other investment funds. It is important to understand your attitude to risk and capacity for loss before making any investments. Our advisers will establish this with you as part of our advice process.
The value of investment trusts, or the income derived from them, can decrease as well as increase and you may not necessarily get back the amount you invested. Past performance is not an indication of future performance and some investments may need to be held for the long term to achieve a return.
