What are they?
Investment trusts are publicly listed companies that invest in financial assets or the shares of other companies on behalf of their investors.
When you invest you are buying shares in an investment trust, the value of which fluctuates based on:
The underlying value of the assets they own
The supply and demand for their shares
How does an investment trust work?
When you purchase shares in an investment trust your money is pooled with other investors and used to purchase a diverse range of shares and assets. In simple terms:
You buy shares in an investment trust
The money from your shares is put into one big pot, with the money from other shareholders - this is called the fund
The fund is then used to buy shares and assets by the fund manager
The value of these shares and assets fluctuate and are bought and sold over time
You sell your shares for the market price
Investment trusts tend to be more stable than buying shares in a single company because your money is invested across a variety of companies. This does not eliminate the risk to your money but means that the performance of a single share has less impact because there are many others to counteract it.
What is a fund manager?
The fund manager is the person responsible for the day to day management of the investment trust's fund. He or she chooses where the fund is invested, when to buy and sell assets, and is the person responsible for whether the funds value grows because of the choices they make.
The fund manager is usually appointed by the investment trust's board of directors, who are also responsible for setting the wider investment strategy that the fund manager will follow.
The investment strategy outlines how the fund manager should invest the trust's money, how much risk they can take, what types of assets they can invest in and their long term plan.
What are asset classes?
They are the type of investment that an investment trust specialises in. Common asset classes include:
Equities/shares e.g. utilities, bio-technologies, alternative energy
Cash e.g. pound sterling, US dollar
Government bonds e.g. UK government gilts
The investment trust's fund manager will usually have experience of investing in certain asset classes and a track record of how their investments have performed in each area.
You can see which asset class, or asset classes, an investment trust specialises in before you make a decision on whether to invest your money.
What is Net Asset Value?
If shares are more expensive than their NAV value they are deemed to be at a 'premium' if they are cheaper they are considered to be 'discounted'.
This is the value of the fund per share, which means the total value of an investment trust's shares and assets minus its liabilities and debts divided by the total number of shares that people hold in the unit trust.
Comparing the NAV to the share price can give you an idea of the demand for shares in the trust.
How much money could you make?
In theory, there is no limit to how much money you could make from investing in an investment trust.
In reality, returns are determined by two main factors:
Performance: The performance of the assets your investment trust has invested in will go a long way to determining its value. Investment trusts spread their investments across a large number of assets, meaning their value is less likely to soar or plummet in a short period of time.
Supply and demand: Investment trusts have a fixed number of shares in the market; this means that supply and demand can influence the cost of their shares and the value of their underlying assets.
Find out more about the different pros and cons of investment trusts here.
Do investment trusts pay dividends?
Dividend payments are never guaranteed.
Yes most investment trusts pay dividends but check with your provider to make sure before you invest.
Those that do pay usually pay them annually, twice a year or quarterly, but some high performing investment trusts have paid dividends on a monthly basis.
What does an investment trust cost?
Like all investments there is a cost to investing in an investment trust, although they can be cheaper than other grouped investments like unit trusts and OEICs. Common fees and investing costs include:
Management fees: These are the fees levied by the fund manager for their services managing the investment trusts fund.
Annual charges: This is an annual charge which covers the cost of investing the fund itself and usually ranges from 0.5% to 1%.
Performance fees: Some investment trusts levy performance fees when the trust outperforms a particular benchmark, for example; if a trust doubled in value then an extra fee could be charged, if it did not reach that level then it would not be applied.
Flat rates: Some investment trusts now levy flat rates rather than % fees; if you have a large amount to invest this can be more cost effective.
All of these fees and costs vary from one investment trust to another and they often have different levels of fees for lump sum depositors and monthly investors so double check what you will have to pay before you make your final decision.
What tax do you have to pay?
They are payments made by companies to their shareholders and are treated as a type of income.
You pay tax on dividends and profits from your investment trust.
Dividends are paid with a 10% tax credit that covers the tax owed by basic rate taxpayers; if you are a higher or additional rate tax payer then you will likely have to pay further tax. You can get more information on the GOV.UK website.
Profits made from investment trusts are subject to normal capital gains tax rules.
What are the risks?
You could lose some or all of your money if your investments perform badly, as they are linked to stock market performance.
Supply and demand can also be a risk to your investment because if demand for your investment trust shares plummets the amount you could sell them for will be much lower than if demand was soaring.
You can limit the risk to your money by choosing an investment trust that invests in low risk asset classes, like cash, or ones that avoid using gearing to fund their investments.
Find out more about the risks of investment trusts before making a decision by reading Should you invest in investment trusts.
What is gearing?
Other grouped investments like unit trusts and OEICs are unable to borrow money to buy shares.
It is another name for borrowing money to fund investments.
Investment trust managers* can borrow money in addition to the money already invested in their fund to get greater leverage and chase bigger returns.
This can allow a fund manager to boost their profits if the borrowed funds are used to buy shares that perform well. If things go badly if can leave an investment trust over exposed and mean your investment loses value at a much faster rate.
If you worry that gearing may put your money at too great a risk then there are many investment trusts that don't use it as part of their investment strategy.
Can you use your ISA allowance?
Yes. Investment trusts can be placed in an ISA wrapper protecting your gains from tax.
Normally any profits you make from investment trusts would be liable for capital gains tax but those included in an ISA are tax free.
How are investment trusts different?
Unlike other types of grouped investments, such as unit trusts & OEICs, an investment trust is a closed ended investment that issues a fixed number of shares.
This can mean that shares for popular investment trusts may not always be available to buy as the full allocation may be held by existing investors.
An investment trust is also a listed company and trades on the value of its own shares on the London stock exchange, as does a unit trust, but OEICs do not.