Investment trusts: an A to Z for beginner investors

They are dubbed a City ‘secret’, and beginner investors should not overlook them.

A year ago, I opened my first stocks and shares ISA and bought a low-cost investment fund. I felt like I had arrived late to the investment party – I am at the tail-end of my thirties – and was just eager to get going. However, now that I know a bit more about investing, I am considering adding an investment trust to my fledgling portfolio.

In my job at Money Observer, I have read countless times that investment trusts are the City’s “best-kept secret”, a description that only made me want to find out more about them. If you are completely new to investing, I feel that trusts are more challenging to understand compared with funds, but if you are willing to invest some time in learning how they work, they are worth considering as an investment option for several reasons, as I outline below.

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First, a brief background on investment trusts, which have been around for a bit. In fact, some are Victorian, according to their age of establishment, with F&C Investment Trust being the oldest of the bunch at 151 years old. Like the managers of investment funds, trust managers invest in a variety of things, including shares and bonds.

In the UK, investment trusts have about £200 billion of money under management, and there are nearly 400 of them, according to Association of Investment Company (AIC) figures. In comparison, there are more than 3,500 investment funds. Investment trusts are companies in their own right, and if you decide to invest in one you will be a shareholder both directly (in the trust) and indirectly (in the companies it holds in its portfolio). Some trusts pay dividends to shareholders, but not all.

You inevitably come across jargon when you’re a beginner investor. Investment funds are referred to as open-ended, meaning they can issue units “on demand”, according to the amount of money being ploughed in by investors. However, investment trusts are closed-ended investments, which means that there is a limited number of shares to buy; they are traded on the stock market, so when lots of investors want to put money into a trust, the share price rises.

Performance watch

As you can see from the table below, over a 10-year period, the average open-ended fund had a share price total return of 106%, while the average investment company was almost double at 200%.

Share price total return (end Jan 2020)

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However, it’s important to bear in the mind that average figures “hide” both the poor and the outstanding investment trust performers. Something called “survivorship bias” may also affect these figures. This bias occurs if an investment trust closes down – possibly owing to poor performance – with its negative figures dragging down the overall average. However, my reason for citing the data above is to highlight that when it comes to long-term investing, historically, investment trusts generally have the edge.

Trusts and funds: spot the difference

Investment trusts are structured differently from funds, and this arguably has some advantages for investors. For example, an independent board of directors oversees the manager of the trust. The board is there to represent investors’ interests and it can dismiss the manager if the trust is consistently underperforming - that is not delivering decent returns for investors. The board also monitors fee levels to make sure investors are getting good value for money.

Gearing is another perceived advantage of trusts. It’s another bit of investment jargon that means borrowing, as some trusts borrow money to invest further, which can boost returns if the market rises, but also enhance losses if it falls.

Investment trusts are under no obligation to share out all the income they make from investments. This means that they can squirrel this money away and when the tough times come, they can use these reserves to bolster their dividends payments to shareholders. Did you know that there are some investment trusts that have increased their dividend payments for more than 50 years? These trusts are known as “dividend heroes”.

Investment trusts are a good way to access a wider variety of assets, such as commercial property, infrastructure or wind farms. Such holdings are often called “illiquid assets” because they take time to sell. If investors decide to withdraw their money from an investment trust en masse, its “closed-ended” structure means that the manager is not forced into trying to sell the wind farm quickly (and perhaps at a low price) in order to release money to investors. Instead, the share price of the trust will fall as investors sell. Being able to invest in a variety of assets becomes increasingly useful as your portfolio grows, helping to avoid the investment “clanger” of having all your eggs in one basket.

Discounts and premiums: what?

An investment trust has two prices to be aware of. The first one is the trust’s share price. An investment trust is a company on the stock exchange and the price goes up and down – just like any other share. However, the share price, because it is driven by investor supply and demand, does not necessarily mirror the value of the stocks held in the trust. Typically, it’s lower than the trust’s real value. In the jargon, the trust is trading at a discount to net asset value (NAV). In other words, a discount is an opportunity to buy shares on the cheap.

If you buy at a discount and that discount then narrows, your holding could gain in value even if there is no movement in the price of the underlying assets. It could even tip over the point when share price is worth the same as net asset value, and turn into a premium to NAV. This means that investors who buy shares are paying more than the underlying assets are worth. Conversely, if the discount widens, your holding could lose more value.

Bills, bills, bills

Some trusts charge fees not much above passive low-cost funds. For example, F&C Investment Trust has an ongoing charge figure of 0.57%, while City of London is 0.39% and Scottish Mortgage is 0.37%.  

There are also trusts that will allow you to invest regularly, which often suits beginners.

Trust tips

My Money Observer colleagues suggest trusts that might suit a beginner.

It depends how long your timescale is, and how much of a taste for risk you have – but for someone with decades to go before retirement, I would suggest F&C Investment Trust for a more cautiously positioned first investment. It is very well diversified, with more than 450 holdings across 35 countries, and low running costs of 0.57%. The manager allocates the portfolio between various different strategies, farming some of them out to external managers. He can also hold up to 20% in private equity, which provides useful exposure to the growing number of unlisted companies.

For a more adventurous beginner, I’d be looking at Monks, one of Baillie Gifford’s long-term, growth-oriented high-conviction stable of trusts. It focuses on companies with strong competitive advantages and above-average earnings growth, and has a well-diversified global portfolio of more than 100 companies. It’s also very cheap, at just 0.5%. Faith Glasgow, editor, Money Observer

I would suggest a multi-manager investment trust is a sensible first investment. Under this structure, a fund manager outsources the stockpicking to other fund managers and typically each one is a specialist in a certain region (the UK, US, Europe, or emerging markets, for example). So, instead of buying shares themselves, the fund manager is more of a puppet master pulling the strings in terms of deciding how the portfolio is structured. Multi-manager funds are a one-stop shop solution, as you are investing in several funds for the price of one.

Three investment trusts that adopt this approach are Witan (the ongoing charge figure is 0.79%), F&C (0.57%), and Alliance Trust (0.64%). Charges for all three trusts, highlighted in brackets, are much lower than open-ended funds that also make use of external managers. They tend to be pricey, costing around 1.25% to 1.75%. Over the long term, charges make a huge difference.Kyle Caldwell, deputy editor, Money Observer