Investment trusts: a versatile choice for long-term investors
- Investment trusts are a flexible, liquid option for investing in a range of asset classes, including shares, bonds and property
- Trusts also have advantages for investors who need an income from their investments
- After a period of volatile markets, investment trust discounts are higher than normal
Investment trusts have stood the test of time. The first investment trust was launched in the 1860s, “to give the investor of moderate means the same advantages as the large capitalists”. They have been fulfilling this role ever since, democratising access to investment markets and bringing choice and diversification to investor portfolios.
The premise of an investment trust (or investment company) is straightforward. They are listed companies that invests in shares, bonds and other assets, such as property. In their simplest form they will invest in a portfolio of shares, but there are also investment trusts that invest in areas as diverse as wind farms, commercial property or student accommodation. The choice is vast, and there is something to suit every investor.
The benefits of the company structure
The company structure brings a number of advantages compared to an open-ended fund such as an OEIC. First, it brings pricing transparency, investors can buy or sell on the stock exchange as they would a normal share. This means it is easy to get access through an investment platform or trading account.
It also means there is a board of directors, who look after the interests of shareholders. This board of directors appoints the investment manager, monitors them to ensure that they are doing their job properly, and can replace them if they’re not. The board will also ensure that the manager is communicating effectively with shareholders, and that the investment goals of the trust are upheld.
Investment advantages
The company structure also allows for more investment flexibility. With an open-ended fund, the investment manager has to buy and sell when capital flows in and out of the fund. If lots of investors want to sell the fund, the fund manager may find that they have to liquidate assets very quickly. This can be difficult, particularly in areas that have lower trading volumes, such as smaller companies, or very illiquid assets such as commercial property. The manager might have to accept a lower price as a result.
Investment trusts are closed-ended, which means managers don’t have to trade the underlying holdings when investors buy in to or sell out of the fund. Fund managers are not as constrained by liquidity considerations when they invest. This makes investment trusts a compelling option for areas such as smaller companies, emerging markets, or property and infrastructure assets.
Investment trusts can be a good option for investors who need an income. Some trusts have a long and illustrious track record of paying high and increasing dividends. It may be written into the investment aims of the trust. The Association of Investment Companies (AIC) compiles an annual list of ‘dividend heroes’ – these are trusts that have raised their dividends every year for 20 consecutive years or more. You should of course always remember that dividends are not guaranteed and past performance does not predict future returns.
The other advantage is that investment trusts can reserve income, saving it up during buoyant years and using that money to support the dividends they pay out out during lean years. This can help ensure a smoother income stream to investors. It was particularly noticeable during the pandemic, when many open-ended funds needed to cut their dividends as their underlying investments cut payouts, while some investment trusts could call on their reserves to keep paying dividends to their shareholders.
Investment trusts can also borrow to invest, known as gearing. This can magnify the returns to shareholders but will also magnify losses on the downside if markets go down. Most conventional trusts run with 5-20% gearing.
Discounts and premiums
Investment trusts are traded on a stock exchange, which means the price is determined by the balance of buyers and sellers. The price may not match the value of the underlying holdings in the trust (the ‘net asset value’ – NAV). This leads to discounts – where the shares trade below NAV – and premiums – when the shares trade above NAV. If a trust’s share price is £80 and its NAV per share is £100, it’s trading at a discount of 20%. Investors are effectively getting £100-worth of assets for £80, which has some appeal for investors that like a bargain.
Selecting investment trusts
There are currently 365 investment trusts including Venture Capital Trusts (or VCTs, which invest in small companies). There is huge choice, split between equities (54%) and alternatives (46%), including significant allocations to private equity, infrastructure and property. There is something to suit every taste.
The right option will depend on whether you are looking for long-term capital growth, income, or for exposure to a specific region or sector. For example, there are Asian, European and North American trusts, others that invest in smaller companies or technology, not to mention those that invest in renewable energy or student accommodation. Each trust has its own specific investment flavour. The AIC has a screening tool that allows investors to find trusts by characteristics such as yield, performance, charges or size.
Why now for investment trusts?
Investment trusts can play a role in portfolios whatever the economic weather. However, there are a number of reasons to look more closely at investment trusts today. The first is income. As interest rates fall, dividend income may become more valuable to investors. Data from the AIC shows that there are 26 investment trusts currently offering a yield of at least 4.5% a year. Many trusts yield more than 5% – and some offer significantly more. However, it is worth noting that the yields from investment trusts are not guaranteed and may vary over time.
After a period of volatile markets, investment trust discounts are higher than normal, particularly in some areas, such as infrastructure and private equity. Currently, more than 90% of investment trusts are trading at a discount, with a fifth trading on a discount of more than 30%. If sentiment improves, discounts could narrow, boosting returns for investors.
Charges may be lower than for their open-ended equivalents. Boards will often exert pressure on the investment adviser to keep costs low. In the first half of 2024 alone, a total of 18 trusts made fee changes to benefit shareholders.
Investment trusts remain a compelling choice for a range of investors, with options for income, growth, or a blend of both. They may have been around for 150 years but remain as relevant as ever for the modern investor.
Important information
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
Other important information:
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG, authorised and regulated by the Financial Conduct Authority in the UK.
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