If you want to invest but don’t want to take the risk of plumping all of your capital into a single company what are the options?
Well, for 150 years, investors have been putting their savings and faith into investment trusts.
Set up as a limited companies with a manager appointed by a board of directors, these are collective vehicles so-called because the money they receive is pooled and spread across a number of investments.
They are also called closed-end vehicles, because the amount of money they can invest is fixed by the number of shares issued when the trust is launched.
Later, the amount of funds available can be increased through subsequent share issues and through borrowing or gearing.
The ability to borrow to boost potential returns is an important difference between investment trusts and other types of collective vehicle such as unit trusts and OEICS.
A question of trusts
As investment trusts are companies, they trade on stock markets in the same way as any other listed firms, they pay dividends and the board of directors are accountable to shareholders at annual meetings.
When launched, a trust will usually specify its strategy such as to pay a certain level of dividends and also the benchmark index it is using to judge the performance of its manager.
Because the share price reflects demand, or lack of, for a trust’s shares at any particular time, they can trade at a premium or discount to the underlying worth of the trust’s portfolio.
Called the net asset value, this worth is the portfolio’s value divided by the number of shares in issue at the time.
If a premium gets too large, a board might decide to issue more shares to satisfy the demand or conversely if the discount is too great a trust can borrow and buy shares back to reduce the gap.
This is one way the ability to borrow gives investment trusts arguably more flexibility than other investment vehicles.
Dividend boosts
Trust rules mean they are also only obliged to pay 85% of any income they receive in a year as dividends, which gives scope to build up a buffer for lean years.
This has sparked a resurgence of interest in recent years, especially among those paying healthy dividends as alternatives such as bank accounts have offered meagre returns.
They are also allowable for inclusion in tax efficient wrappers, such as ISAs and SIPPs, which has also boosted their appeal as any dividends or capital gains are free of tax.
The first investment trust was launched well over 100 yers ago and is still going strong.
Indeed, so successful has been the structure that there are now more than 400 for investors to choose from covering all regions, types of investment and speciality trusts such as split caps and venture capital trusts or VCTS.
A potted history
The first investment trust was set up by Foreign and Colonial back in 1888, but far from being an outdated form of investment, interest in trusts is thriving.
Why is this?
The obvious answer is because it offers a tax-efficient way to spread risk and avoid dilution.
Legally-speaking, the investment trust is closed-ended, meaning that although investors can buy and sell to each other on the London stock exchange, the units themselves cannot be redeemed for cash. This means that in times of trouble investment trusts tend to hold firm while other funds are sent reeling through a combination of redemptions and collapsing asset values.
As a result, investment trusts have proved an enduring and popular way to invest, because as followers of Warren Buffet know, the way to win big is to buy and hold.
An investment trust is a public listed company. It’s designed to generate profits for its shareholders by investing in the shares of other companies. But it also means that shareholders have the right to decide on important issues, such as the appointment of directors.
Because an investment trust has a fixed number of shares, the fund manager can invest and sell assets when they feel the time is right, not when investors join or leave a fund. This allows the fund manager to draw on his own wells of experience rather than being dictated to by the market and it also means the underlying capital investment base is relatively stable.
Investment trusts usually have smaller operating costs than Funds also known as OEICs (Open Ended Investment Companies) so their charges are generally lower.
They can also borrow money to take advantage of investment opportunities. Borrowing can increase the returns for shareholders, but if the assets fall in value, it can also increase the potential for losses.
However, like other asset classes traded on the London stock exchange, the valuations of investment trusts can change significantly over the short term. The BlackRock World Mining Trust is a good example of this, liable to be pushed up strongly by positive sentiment in a rising commodities market, and punished heavily when sentiment turns down again.
For the steadier investor, the most popular trust in recent months has been Scottish Mortgage, which is heavily slanted towards technology and which entered the FTSE-100 in the latter part of 2017.