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What Are Investment Trusts?

Written by, Marija Petkova

Updated September, 7, 2022

If you’re looking for an investment that generally delivers decent rates for reasonable charges, you might want to consider investment funds.

But, what are investment trusts, how do they work, and are they a good idea for you? 

Let’s dive in.

What Is an Investment Trust?

An investment trust is a pooled investment.

Although there are different types of investment trust, all investment trusts are public limited companies, often with a fixed number of shares on the stock market. 

The company sells its shares to investors and then pools the money to invest on their behalf, in other companies. 

Investment trusts are listed on the stock exchange and their share price fluctuates, so investors can make a profit, depending on how the share price performs.

How do investment trusts work?

Investment trusts are led by a board of directors. Although they are responsible for the investment trust and are expected to set policies regarding investing, they are usually required to hire a portfolio manager to make investment decisions on behalf of the company and maximise profit. 

Investment trusts, like all pooled investments, have specific objectives. Some target large companies on a global scale and others are more niche. They mostly invest in companies, but there are some that buy shares of financial assets as well.

How much money could you make? 

Investment trust companies provide a wide range of returns. 

This is due to the fact that they are invested in various areas and utilise diverse investment strategies. Even though this doesn’t eliminate the risk of loss, it can help to mitigate volatility and reduce risk.

Whatever trust you pick, your returns will be determined by two main factors:

  1.  Investment trust performance    

The value of your investment trust is determined by the performance of the assets it has invested in. Because investment trusts distribute their assets across a wide range of assets and companies on a regular basis, their value is less likely to rise or fall dramatically.

  1. Supply and demand

Investing trusts have a set number of shares in the market, which means that supply and demand for their stock and assets can influence their price.

Investment trusts for income

Investment trusts, like other pooled investment funds, earn interest on the majority of the money they invest. They can earn dividends from firms with shares in which they have invested and may get paid interest on loans obtained by governments and businesses.

Investment Trust vs Unit Trust

Investment trusts are public limited companies and are closed-ended funds with a fixed number of shares. Unit trusts, on the other hand, are open-ended funds that issue new units in response to demand.

This also means that you can’t buy a share after an investment trust’s launch unless an investor wants to sell theirs.

Investment trust vs fund

The major difference between an investment trust and fund is that open-ended funds are not allowed to borrow money. This process, known as gearing, can help boost returns. 

Also, the income earned by the underlying assets may in investment trusts be “reserved,” or set aside, in any year to create a safety net if future years turn out to be leaner. Many trusts take advantage of this provision by striving to increase their dividend payouts each year, resulting in long histories of dividend increases.

Investing funds must pay out all of the fund’s underlying assets’ earnings to shareholders.

What Can Investment Trusts Offer?

Easy access

Investment trusts are great for beginners and a safe and secure investment for any investor (as secure as investing can be) because it gives them access to a collection of investments, picked out by a professional fund manager similar to robo-investing

Simplicity

Since investment trusts have a fixed number of shares and investors rarely sell their shares, they are less complicated to understand. What’s more, there’s a portfolio manager in charge of the investment decision, which makes the investment less expensive to manage and less time-consuming.

Income potential

Investment trusts are one of the most reliable sources of income. They are less susceptible to market volatility and can keep their portfolio fully invested at all times. They can also retain up to 15% of their revenue, allowing them to continue providing consistent payments by using reserves.

However, not all investment trusts may build up reserves, and even where there is an excess of cash, it might not be enough to last through a period of bad market performance.

Gearing 

Investment trusts can borrow in different ways and at favourable interest rates. This can help clients benefit from greater exposure in rising markets through “gearing,” but they may suffer more when stock prices fall.

Accountability 

Investors in investment trusts have the power to hold the company accountable and cast votes at AGMs.

How to Choose an Investment Trust

When choosing an investment trust, it’s important to understand the company’s investment strategy and its investing niche. It’s also worth-checking if their platform is user-friendly.

Some trusts focus on capital growth, others on income generation, and there are investment trusts that have a specific geographical focus. It’s also important to look at a trust’s historic performance to get an idea of how it has fared in different market conditions.

It’s also worth considering the level of gearing a trust uses – this is the amount of debt it takes on to increase its returns. Higher levels of gearing can lead to bigger profits when markets are rising, but can also result in greater losses when they fall.

Finally, investors should check how much the trust charges in fees. Some trusts have high management fees which can eat into returns, so it’s important to compare different trusts before investing.

Investment trusts can offer many advantages over other types of investment, but they’re not suitable for everyone. 1.4% of shares in the UK market are held by investment trusts, and more than half are held by foreign investors. 

How much do investment trusts cost?

Fees that investment trusts usually charge, include: 

  • Management fee

The investment trust fund manager charges a fee for managing the trust. This fee is also called a management expense ratio.

  • Performance fee

In certain investment trusts, investors are required to pay a performance fee if the trust outperforms certain standards or goals. If your trust increases in value by 100%, for example, you may be required to pay an extra fee. 

  • Annual charge

The annual charge covers the cost of investing in the trust and is generally between 0.5% and 1%.

Do you pay taxes on investment trusts?

The tax laws for investment trusts in the UK are the same as those for any other investment fund. 

Investors can be taxed on dividends and earnings if they surpass the annual dividend allowance of  £2,000. Taxes for earnings are paid separately and the amount is determined by your income tax band.

When you sell your shares for a profit, you may be required to pay capital gains tax as well. The annual tax-free cap is  £12,000 in profit.

Disadvantages of investment trusts

While there are many advantages to investing in investment trusts, they can be pricey, with management fees and annual charges typically higher than those of other investment funds. 

What’s more, investment trusts are not required to distribute all of the income they generate to investors, meaning that they can retain some of the profits made. This can be beneficial if the trust performs well but can also lead to a decrease in value. 

Bottom Line 

Investment trusts can be a great way to invest your money, but it’s important to do your research on what investment trusts are before you buy since investors are subject to different fees and taxes.

Still, investment trusts have a decent return rate, similar to multi-asset investing, but they are also less susceptible to market volatility, and can borrow money to increase profit. 

My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.