Investment Trusts: a beginner’s guide

Investment trusts are closed-ended funds that are actively managed by a fund manager and are generally aligned to a geographical region, sector or benchmark index. In this guide, you’ll learn about the following:

1. What are investment trusts?
2. Do investment funds pay dividends?
3. What is the difference between a stock and an investment trust?
4. Are investment trusts better than funds?
5. How do I choose an investment fund?
6. How do I buy investment trusts?
7. How do I compare investment funds?

Investment trusts are financial vehicles that pool funds from investors.  They then invest that capital into a diversified portfolio of stocks, bonds, or other securities. An investment trust will typically be aligned with a geographical region or sector and a benchmark index.

Unlike mutual funds, investment trusts are structured as closed-end funds.  This means that they have a fixed number of shares to be bought and sold. The fixed limit means investment trusts trade at a premium or discount to their net asset value (NAV), depdnding on demand.  Higher demand means a higher premium; lower demand means more discount.

Investment trusts are managed by professional fund managers or investment companies who use asset allocation and stock selection to achieve the fund’s objectives.

The primary objective of an investment trust is to generate returns for its shareholders through a combination of capital appreciation and income generation.

Investment trusts often distribute income generated from their investments to shareholders in the form of dividends. Shareholders can either reinvest these dividends to acquire more shares or receive them as cash.

The closed-end structure, combined with active management and the potential for leverage, makes investment trusts suitable for investors seeking exposure to a diversified range of assets within the objectives of the investment fund with the potential for capital appreciation and income generation.

A stock represents ownership in a single company, entitling the holder to a share of that company’s profits and voting rights. In contrast, an investment trust is a pooled investment fund that owns a diversified portfolio of stocks, bonds, or other assets. While stocks are individual equity securities, investment trusts are closed-end funds traded on the stock exchange.

Investment funds offer diversification benefits and professional management, while stocks are more focused on the performance of a specific company. Additionally, investment trusts may use leverage and can trade at a premium or discount to their net asset value.

There is no definitive answer on whether investment trusts are better than funds, as it depends on individual investor preferences and goals. Investment funds offer potential advantages like closed-end structures, active management, and the ability to trade at a premium or discount. However, they may also carry higher risks due to the use of leverage.

Funds, such as mutual funds or exchange-traded funds (ETFs), often provide diversification, liquidity, and lower fees, making them suitable for some investors. The choice between investment trusts and funds should align with an investor’s risk tolerance, investment strategy, and specific financial objectives.

Choosing an investment trust involves careful consideration of your financial goals, risk tolerance, and investment time horizon. Here are a few factors you need to consider before you take the plunge:

Define Your Goals
Clearly identify your investment objectives, whether it’s capital appreciation, income generation, or a combination of both.

Risk Tolerance
Consider your tolerance to risk to determine the level of volatility and potential losses you are comfortable with. Investment funds can vary in risk depending on factors such as asset allocation and leverage.

Research
Conduct thorough research on potential investment funds. Examine their historical performance, fund manager’s track record, and the underlying assets in their portfolio.

The Association of Investment Companies (AIC) represents 350 investment companies. On the AIC website, you’ll find lots of tools and resources to help you start your investment trust journey. You can compare investment companies, filter results and much more. Make sure you sign up to their monthly newsletter too. Websites like Trustnet, Citywire and Morningstar are also useful resources.

Diversification
Look for trusts with diversified portfolios across different sectors and regions. Diversification helps spread risk and reduces the impact of poor performance in any single investment.

Costs and Fees
Consider the costs associated with the investment fund, including management fees and other expenses. Lower fees can enhance your overall returns.

Premium or Discount
Check whether the investment fund is trading at a premium or discount to its net asset value (NAV). A discount might present a buying opportunity, while a premium could indicate market optimism.

Manager Expertise
Evaluate the expertise and reputation of the fund manager. A skilled and experienced manager can significantly impact the trust’s performance.

Dividend Policy
If income is important, assess the trust’s dividend history and policy. Some investment funds focus on income generation through regular dividend payments.

Leverage
Understand if the trust uses leverage and evaluate your comfort level with the additional risk associated with borrowed funds.

Reviews and Ratings
Consider professional reviews, ratings, and recommendations from reputable sources to gain insights into the trust’s reputation and performance.

So you think investment trusts are right for you and your portfolio? Here’s what you need to do next.

1. Do your research: You’ll need to visit the websites we mentioned above to identify the investment company(s) that align with your financial goals and risk tolerance. Consider factors like diversification, performance, dividends and the costs associated with owning the fund.

2. Open an account with an Investment Platform: Choose a reputable investment platform to facilitate your transactions, one that is authorised by a world class regulator, such as the FCA. If you are a UK resident, you can purchase investment trusts within your Stocks & Shares ISA allowance. Check out our stocks and shares ISA platform comparison to find the right broker for you.

3. Fund Your Account: Deposit the required funds into your brokerage account. Bear in mind the minimum amount will vary from platform to platform.

4. Place an Order: Use the investment platform to place buy orders for the desired investment fund(s).

5. Specify Quantity: Indicate the number of shares you want to purchase.

You will be able to monitor your investment and make adjustments where you need to. However, it is important to bear in mind your investment strategy and goals. Investing in investment funds suits investors with a longer term objective.