A complete guide

Investment Trusts

What are investment trusts and how do they work? We explore everything there is to know about investing in trusts, from OEIC’s to Unit Trusts.

What is an investment trust?

An investment trust is a type of fund that has been set up as a company. The goal of this is for the shares to be bought and sold on the London Stock Exchange, where the trust will usually invest in other companies, aiming to generate profit for the shareholders.

There will always be an investment manager appointed to ensure that the trust is run properly, including investing in a portfolio of shares, property and other assets that may be profitable. When you are buying shares in an investment trust, the price of these shares is based on both the performance of the companies invested in as well as the supply and demand.  It’s important that the portfolio is diverse in order to reduce any risk that may be posed.

Types of investment trusts

Oeics

OEICS stands for open-ended investment company. It’s a collective investment scheme that pools the money of many different investors and then this money is used to invest in a range of different assets.

They are called open-ended because this kind of fund or scheme can create a new share to keep up with investor demand. As well as this, the fund will cancel the shares of any investor that leaves the fund.

Unit trusts

Unit trusts are managed by fund managers in order to achieve a specific return. The money is all pooled together so that the fund manager can invest in different assets. The total fund is divided into equal units that you hold onto and hope to make money off the assets in the unit. You can exit the fund at any time.

Open-ended vs Closed-Ended trusts

There are two types of investment trust, and these are open-ended and closed-ended. Open-ended funds are named so because they can create new shares to keep up with demand, where closed-ended trusts issue a fixed number of shares through the fund.

Why invest in trusts?

If you are seeking income from your money, then investment trusts are a good option for you. They earn income on most of the money that they invest, so it can become a fantastic form of income for the person who is involved in the trust.

You can also receive dividends from companies whose shares you hold, earning you an extra sum of money. It comes with a level of risk in the same way that all investments do, but it is managed by a professional, experienced manager so you have knowledge on your side.

Where do trusts invest?

Investment trusts can invest in a number of different places to ensure that their portfolio is as diverse as possible. Doing this minmises the risk that there are going to be losses in the investment trust. That is why the trust manager will look into a number of different pursuits such as shares, property and a number of other assets.

Each of these is going to be carefully chosen to ensure that they are the best choices for the investment trust overall. These will be reviewed every so often by the manager, and they will decide whether to pursue new investments, whether to sell the shares and so on.

How to choose an investment trust?

There are a number of ways that you can choose what investment trust to go with. First, you need to establish what the purpose of your investment is going to be. There are a number of reasons someone would want to purchase an investment trust, and once you have identified yours, you can find the trust that is right for you.

You should also be looking at the past performance of each investment trust before you make a choice. This is going to give you some of the answers that you are looking for as you will be able to see how the fund has been performing.

Make sure that you are using a reliable source to gain your information. Financial advice is always recommended before any investment decision, especially if you are new to investing.

The benefits of trusts

There are a number of benefits of investment trusts. Each different trust will bring its own benefits of course, however there are some general benefits that you can expect when you purchase:

• They offer the potential for a more consistent income as they are able to retain up to 15% of their net income each year.
• There is a separation between the portfolio and the dealing in shares, meaning the portfolio is invested fully at all times.
• Buying and selling the trust’s shares does not mean that the manager has to make a change to the portfolio overall. This allows the manager to focus on the long-term. 
• Investment trusts use gearing to boost returns, which is something that OEICs are not able to do.
• Investment trusts will have access to a wider range of investments, making them superior to other funds.

Understanding gearing

Gearing is one of the secret weapons that investment trusts have. These trusts have the ability to borrow money in order to buy shares or assets. These are often borrowed at favourable rates of interest. Gearing allows clients to benefit from additional exposure in rising markets, however, if the stock prices fall then the investments may be hit harder than they would be otherwise. 

Gearing is generally used to generate more wealth by allowing for investments that would otherwise not be possible. The money that has been borrowed can be invested in a variety of different ways depending on what the investment trust manager has decided.

What factors affect returns on investment trusts

Of course, there are going to be a number of factors that will impact the return on investment for the trust. You need to look at all of these factors before you decide whether or not investment trusts are right for you. Some of them are as follows:

• The performance of the trust manager and the decisions that they make.
• Investor behaviour will always have an impact on the overall result of the fund as this will impact the price of the shares.
• Investment costs and tax are both going to play a vital role on the return
• Time is going to be your greatest friend or your greatest foe. Everything changes, and you can never guarantee what way things are going to go

Tax, Dividends and profits

Tax on investment trusts are the same as they are on any other type of investment fund. What this means is that you will need to pay tax on any and all dividends and profits. The more you make, the more tax you pay. As these trusts are set up as limited companies, they will have to follow regular tax guidelines. 

Understanding the risks

There is a risk with every single type of investment that you make. Even if you are using professional advice and knowledge, there is still no guarantee that you’re going to see the return that you are looking for. In fact, you could end up losing the majority of your money, so think this through carefully.

Financial Advice for investment funds

Funds are generally less risky than buying shares individually. While they are less risky, they are still funds that are deemed as high risk, so it’s essential that you do your research before you dive into the world of investing.

Also, while it’s important to look at past data when choosing the right investment trust, this does not mean that it’s an indicator for the future, so this is not the be all and end all of the trust or fund.

An investment advisor can really help you to make the best decisions, bespoke to your situation.

Investment trust FAQ

About Alex McCann - DipPFS & CeMAP

Alex graduated from Leeds Metropolitan University in 2013 and has worked in the financial services industry since 2016. Alex has completed the Chartered Insurance Institute Diploma in Regulated Financial Planning (DipPFS) and the London Institute of Banking and Finance Certificate in Mortgage Advice and Practice (CeMAP) qualifications.

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