What is the difference between an investment trust and an investment company?

Investment trusts

Both run closed-ended funds with fixed capital structures and sell their shares on the stock market.

They take investors' money and pool it to purchase a spread of investments.

Nowadays, the different labels are used mainly to distinguish between onshore investment companies (investment trusts) and offshore versions (investment companies).

 

Q: So how did investment trusts become so named?

A: It is a relic of the past. Investment trusts date back to 1868. Some of the earliest investment trusts were legal trusts, while others were structured as companies from the start.

John Newlands explains what happened next in his history of the investment trust industry, Put Not Your Trust in Money.

He writes: "Following a legal test case - Sykes v Beadon, 1878 - investment trusts were directed to convert to the company form or face being compulsorily wound up.

"This threat caused the trusts to turn themselves into investment trust companies as quickly as they could - only to find, having done so, that the Sykes v Beadon judgement was reversed on appeal.

"In the meantime, however, the company form had been found to have several advantages, such as the ability to borrow money to enhance investment returns.

"There was no going back, and the formal title investment trust company prevailed, as did the informal abbreviated title investment trust."

Q: Does the term investment trust have any legal relevance?

A: The term is still used by the UK tax authorities. For investment companies to be exempted from paying tax on the capital gains they make from the sale of investments in their portfolios, they must be deemed an 'approved investment trust company'.

This means they must satisfy certain legal requirements, such as having a spread of investments, trading their shares on the stock market and not retaining more than 15% of their annual investment income.

An approved company can call itself an investment trust (but doesn't have to), but an unapproved offshore investment company cannot.

Q: Why have some investment companies set up offshore?

A: Mainly because of the types of assets they invest in and for income flexibility. Until recently, approved investment trust status was only open to companies distributing income from shares.

Companies investing in areas such as property, infrastructure and hedge funds did not qualify. However, after changes to the rules and the introduction of real estate investment trusts, there is no longer a problem, so many investment companies have moved back onshore.

 

Q: How do the differences between investment trusts and offshore investment companies affect investors?

A: When you buy shares in an investment trust, you have to pay government stamp duty of 0.5% on top of the price of the shares. There is no stamp duty to pay if you buy shares in an offshore investment company. Otherwise, there are no tax differences.

Q: Is there any difference in the level of protection offered?

A: Neither onshore nor offshore investment company investors are covered by the Financial Services Compensation Scheme. However, if a regulated adviser mis-sells shares in either type of company, investors will be covered.

Reassuringly, investment companies must have independent boards of directors, who are there to protect shareholders' interests, while offshore companies are based in the Channel Islands, where corporate governance is seen as being on a par with that in the UK.

Q: Will the term investment trust continue to be used?

A: In 2006, the Association of Investment Companies (AIC), then known as the Association of Investment Trust Companies, stopped using the word trust, to make its membership more attractive to offshore investment companies. The AIC nowadays uses the term 'investment company' as a catch-all.

However, it believes the term investment trust will continue to be used in common parlance to describe closed-ended funds onshore.

This story was originally written for our sister magazine, Money Observer.

Published: 27 February 2017
Last updated: 27 February 2017

More About

Leave a comment