Why you should own an investment trust

Published by Fiona Hamilton on 20 July 2011.
Last updated on 20 July 2011

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There have been many benefits to investing through an investment trust, but the bottom line is this - like unitised investment funds - they offer ordinary investors access to a well-diversified, professionally managed portfolio of shares.

For investors with larger portfolios, an additional advantage of these collective investments is that changes to the underlying shareholdings are free of capital gains tax (CGT) even if they are not sheltered within an ISA or pension plan.

Investment funds are much more heavily promoted by investment groups, and by financial advisers; there's also a much larger universe from which to choose: over 2,400 UK-domiciled funds, against 274 trusts and UK-quoted offshore investment companies (excluding venture capital trusts and hedge funds).

But investment trusts have the edge when it comes to performance - a key reason why Money Observer has long championed their use and given them extensive coverage. Recent research by Alan Brierley, head of research at stockbroker Collins Stewart, found that over the decade to the end of 2010 investment trusts on average outperformed unitised funds in eight of the nine main sectors, including global growth, UK growth, North America, Europe excluding the UK and UK equity income. Only the UK smaller companies investment trust sector failed to beat its unit trust equivalent.

Close-end structure

A second reason for using trusts is their closed-end structure (meaning there are a fixed number of shares in circulation), which makes them better suited than open-ended funds when it comes to investing in illiquid but potentially rewarding areas such as very small companies, frontier markets or specialist sectors such as biotechnology.

Because they are closed-ended, an increase in demand for the trust's shares or a mass exodus or shareholders will affect the share price on the open market, but not the amount of money under management.

So managers don't have to worry about large inflows or outflows of cash when their investment remit goes in or out of favour. Such surges can harm thew returns of open-ended funds, because incoming money can force fund managers to buy new shares even if the market is looking expensive, while outflows may mean that they have to sell holdings into a falling market.

Being closed-ended is even more critical in the private equity space, where managers need several years of active involvement to get the most out of their investments.


A third attraction of trusts compared with unitised funds is that they offer little or nothing in the way of upfront and annual commission payments to financial advisers. This keeps costs down, contributing to their superior performance.

Other important aspects of trusts include their ability to gear and to issue different classes of shares, and their discounts.

Gearing means borrowing extra funds to invest. This can accelerate returns in a rising market, but will exacerbate losses in hard times, so those of a nervous disposition should opt for ungeared trusts.

Splitting trusts into different groups of shareclasses allows different groups of shareholders to concentrate on their priorities, be they income or capital growth. 'Split caps' have been unpopular since the furore of the early noughties, but a number of trusts have recently raised new funds by issuing zero dividend preference shares (which pay no dividends but offer a pre-determined rate of capital growth).

If these do not rank behind hefty bank borrowings for repayment and are well covered by assets from the start, zeros should provide relatively steady capital appreciation over a finite period. For low-risk investors they are even more appealing as all their returns are treated as capital growth, and therefore tax-free if sheltered within an ISA or covered by your CGT allowance.

Share price discount

Finally, a widening share price discount to a trust's net asset value (NAV) is bad news for shareholders who want to sell, but unimportant for long-term holders and can be good news for prospective buyers. It means they will get more in underlying assets than if they wee buying into a fund with an identical portfolio. Dividend yields should also be higher, and if the discount tightens they should enjoy enhanced returns. Many trusts now muse share buybacks or other measures to limit the extent of discount volatility.

Trusts arguably need to do more to educate both advisers and investors, but it is those complexities that create scope for finding profitable anomalies - but only if you understand what is happening.

This article was written for Money Observer   


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