what is an investment trust Explained

Ashly Chole Senior Finance Researcher

Last Updated 10 April 2024

What is an Investment Trust and How Does It Work?

An investment trust is a type of closed-end investment company that pools money from multiple investors to invest in a diversified portfolio of assets. The assets can range from stocks, bonds, real estate, commodities, and other financial instruments. An investment trust is created as a public limited company (PLC) and is listed on a stock exchange. It is managed by a board of directors and an investment manager responsible for making investment decisions and managing the trust's assets.

Investment trusts issue a fixed number of shares that can be bought and sold on a stock exchange. The price of the shares is determined by supply and demand, which can cause the share price to trade at a premium or a discount to the net asset value (NAV) of the trust's assets. The NAV is calculated by subtracting the value of the trust's liabilities from its assets and dividing the result by the number of outstanding shares.

Who Uses An Investment Trust?

Investment trusts are a popular choice among diverse investors seeking various financial goals. These savvy individuals range from high-net-worth individuals looking to safeguard and grow their wealth to financial advisors seeking investment solutions for their clients.

Institutional investors, such as pension funds, are also attracted to investment trusts because they can generate long-term returns that match their liabilities. Moreover, fund managers and other investment professionals seek exposure to specific markets or sectors by investing in specialized trusts.

Regardless of their financial expertise or investment goals, individual investors are also drawn to investment trusts for their ability to provide a diversified portfolio of assets. Investment trusts allow them to mitigate risk and capitalize on opportunities across various markets and sectors.

At the end of the day, investment trusts are a versatile tool for investors looking to grow and preserve their wealth over time.

Investment trusts are used by a wide range of investors, including:

  • Individual investors looking for a way to invest in a diversified portfolio of assets
  • High-net-worth individuals seeking to grow and preserve their wealth
  • Institutional investors, such as pension funds, seeking long-term returns to match their liabilities
  • Financial advisers looking for investment solutions for their clients
  • Fund managers and other investment professionals seeking exposure to a particular market or sector

What Are the Benefits of Investing in an Investment Trust?

Investing in an investment trust can offer several benefits, including:

  • Diversification: Investment trusts offer investors the opportunity to invest in a diversified portfolio of assets, which can reduce risk.
  • Professional Management: Investment trusts are managed by professionals who have the expertise and resources to make informed investment decisions.
  • Liquidity: Shares of investment trusts can be bought and sold on a stock exchange, providing investors with liquidity and the ability to exit their investments quickly.
  • Transparency: Investment trusts are required to provide regular reports and disclosures, making it easier for investors to monitor their investments.

How Is an Investment Trust Different from Other Investment Vehicles?

Investment trusts are different from other investment vehicles, such as mutual funds and exchange-traded funds (ETFs), in several ways:

  • Closed-End Structure: Investment trusts have a fixed number of shares that trade on a stock exchange, while mutual funds and ETFs issue and redeem shares based on investor demand.
  • Leverage: Investment trusts can borrow money to invest, while mutual funds and ETFs cannot.
  • Lower Fees: Investment trusts generally have lower fees than mutual funds and ETFs, which can make them a more cost-effective investment option.

What Types of Assets Do Investment Trusts Typically Invest In?

Investment trusts can invest in a variety of assets, including:

  • Equities: Investment trusts can invest in stocks from different markets and sectors.
  • Bonds: Investment trusts can invest in fixed-income securities, such as government bonds and corporate bonds.
  • Real Estate: Investment trusts can invest in commercial and residential properties.
  • Infrastructure: Investment trusts can invest in public works projects, such as airports, toll roads, and utilities.
  • Commodities: Investment trusts can invest in physical commodities, such as gold and silver, or commodity futures contracts.

How Is the Performance of an Investment Trust Measured?

An investment trust's performance is measured by its NAV and share price total return. NAV measures the value of the trust's assets minus its liabilities. Share price total return measures the change in the share price plus any income generated from dividends or interest. The performance of an investment trust is also compared to a benchmark index, which represents the overall performance of a specific market or asset class.

What Fees Are Associated with Investing in an Investment Trust?

Investors in investment trusts typically pay annual management fees, which cover the cost of managing the trust's assets. The fees can vary depending on the size and complexity of the trust's portfolio. Other fees may include brokerage, transaction, and performance fees if the investment manager outperforms a benchmark.

How Do Investment Trusts Generate Income for Investors?

Investment trusts generate income for investors in several ways, including:

  • Dividends: Investment trusts can distribute income generated from their portfolio holdings in the form of dividends to their shareholders.
  • Interest: Investment trusts can earn interest income from their fixed-income holdings, such as bonds.
  • Rental Income: Investment trusts that invest in real estate can earn rental income from their properties.
  • Capital Gains: Investment trusts can generate capital gains when they sell holdings for more than they paid for them.

What Are the Risks Associated with Investing in an Investment Trust?

Investing in an investment trust comes with several risks, including market, liquidity, leverage, and management risks. Market risk refers to the risk of the value of the trust's holdings decreasing due to market fluctuations. Liquidity risk refers to being unable to sell shares at a fair price due to a lack of buyers or sellers in the market. Leverage risk refers to the risk of the trust borrowing money to invest, which can amplify gains and losses. Management risk refers to the risk of the investment manager making poor investment decisions or failing to achieve the trust's objectives.

How Are Investment Trusts Managed?

Investment trusts are managed by a board of directors and an investment manager. The board of directors is responsible for overseeing the investment manager, setting the trust's investment objectives, and ensuring that the trust operates in its shareholders' best interests. The investment manager is responsible for making investment decisions and managing the trust's assets by the trust's objectives and investment policy.

How Do Investment Trusts Differ from Mutual Funds?

Investment trusts differ from mutual funds in several ways, including:

  • Closed-End Structure: Investment trusts have a fixed number of shares that trade on a stock exchange, while mutual funds can issue and redeem shares based on investor demand.
  • Leverage: Investment trusts can borrow money to invest, while mutual funds cannot.
  • Lower Fees: Investment trusts generally have lower fees than mutual funds, which can make them a more cost-effective investment option.

How Do Investment Trusts Differ from Exchange-Traded Funds (ETFs)?

Investment trusts differ from ETFs in several ways, including:

  • Closed-End Structure: Investment trusts have a fixed number of shares that trade on a stock exchange, while ETFs can issue and redeem shares based on investor demand.
  • Active Management: Investment trusts are actively managed, while many ETFs track passive indexes.
  • Leverage: Investment trusts can borrow money to invest, while ETFs cannot.

What Is the History of Investment Trusts?

Investment trusts have existed since the 19th century, with the first investment trust established in the UK in 1868. The trust was called the Foreign & Colonial Investment Trust, which aimed to provide small investors access to a diversified portfolio of foreign securities. Investment trusts became popular in the UK and were later introduced in the US in the early 20th century. Today, investment trusts are available in many countries and have become a popular investment option for individual and institutional investors.

What Are the Advantages of Investing in a Closed-End Fund versus an Open-End Fund?

Closed-end funds, such as investment trusts, offer advantages over open-end funds, such as mutual funds. Closed-end funds have a fixed number of shares, which can prevent the investment manager from selling holdings to meet investor redemptions. Closed-end funds can reduce the impact of short-term market fluctuations on the trust's holdings. Closed-end funds can also use leverage, amplifying gains and losses. Additionally, closed-end funds typically have lower fees than open-end funds.

What Is the Role of the Board of Directors in an Investment Trust?

The board of directors in an investment trust is responsible for overseeing the investment manager, setting the trust's investment objectives, and ensuring that the trust operates in its shareholders' best interests. The board of directors is also responsible for approving the trust's dividend policy and overseeing the trust's compliance with regulatory requirements. The shareholders elect the board of directors and must act independently of the investment manager.

How Are Investment Trusts Structured?

Investment trusts are structured as public limited companies (PLCs) and are listed on a stock exchange. They issue a fixed number of shares to be bought and sold on the exchange. Investment trusts are managed by a board of directors and an investment manager responsible for making investment decisions and managing the trust's assets. Investment trusts can use leverage to invest, and they must distribute at least 85% of their income to shareholders in the form of dividends.

What Is the Role of the Investment Manager in an Investment Trust?

The investment manager in an investment trust is responsible for making investment decisions and managing the trust's assets by the trust's investment policy and objectives. The investment manager is typically a professional investment firm with a team of professionals conducting research and analysis to identify investment opportunities. The investment manager is also responsible for monitoring the trust's holdings and adjusting the portfolio as necessary to achieve the trust's objectives.

How Do Investment Trusts Distribute Their Profits to Shareholders?

Investment trusts distribute their profits to shareholders through dividends. The dividend amount is determined by the trust's dividend policy, which the board of directors approves. Investment trusts must distribute at least 85% of their income to shareholders to maintain their tax-efficient status. The dividend is typically paid out quarterly or semi-annually.

What Is the Process for Buying and Selling Shares in an Investment Trust?

Shares of investment trusts can be bought and sold on a stock exchange, just like stocks. Investors can order with their broker to buy or sell investment trust shares. The price of the shares is determined by supply and demand, which can cause the share price to trade at a premium or a discount to the net asset value (NAV) of the trust's assets.

What Are the Tax Implications of Investing in an Investment Trust?

Investing in an investment trust can have tax implications for investors. Investment trusts must distribute at least 85% of their income to shareholders in the form of dividends to maintain their tax-efficient status. The dividends shareholders receive are subject to income tax, and the tax rate depends on the shareholder's tax bracket. Capital gains generated by the investment trust may also be subject to capital gains tax if the shares are sold at a profit.

What Factors Should Investors Consider When Evaluating an Investment Trust?

When evaluating an investment trust, investors should consider several factors, including:

  • Investment Objective: Investors should consider whether the investment trust's objective is aligned with their investment goals and risk tolerance.
  • Performance: Investors should review the investment trust's historical performance compared to its benchmark and peers.
  • Portfolio Holdings: Investors should review the investment trust's portfolio holdings to assess its diversification and exposure to different asset classes and sectors.
  • Management: Investors should consider the investment manager's experience and track record, as well as the stability of the investment team.
  • Fees: Investors should consider the investment trust's fees and expenses, including management fees and any other costs associated with buying and selling shares.
  • Risks: Investors should consider the risks associated with investing in the investment trust, including market risk, liquidity risk, leverage risk, and management risk.
  • Dividend Policy: Investors should review the investment trust's dividend policy and historical dividend payments to assess the trust's income potential.

Investors should also consider their investment goals, risk tolerance, and investment time horizon when evaluating an investment trust and seek professional advice if necessary.

Are Investment Trusts Legal?

Yes, investment trusts are legal entities established under the laws and regulations of the country in which they are registered. In many countries, government bodies regulate investment trusts, such as the Securities and Exchange Commission in the United States or the Financial Conduct Authority in the United Kingdom, to ensure that they operate within established legal and ethical frameworks.

Investment trusts are typically structured as closed-end investment companies that issue a fixed number of shares to investors and invest the proceeds in a portfolio of assets, such as stocks, bonds, and real estate. Investors buy and sell shares of the investment trust on stock exchanges, just like they would buy and sell shares of any publicly traded company.

It's important to note that investing in investment trusts carries risks, and investors should carefully consider their investment objectives, risk tolerance, and financial situation before investing in any investment trust. Investors should also consult with a financial advisor to determine whether investing in an investment trust suits their needs and circumstances.