An investment trust is a company whose business is investing in other assets, such as shares, bonds, property or infrastructure. Its own shares are listed on a stock exchange, so you buy and sell them like any other listed company. Investment trusts have a long history in the UK, and they work in a slightly different way from the funds most beginners come across first.
How an investment trust works
When you buy shares in an investment trust, you own part of a company that holds a portfolio of investments chosen by a professional manager. The trust has a board of directors whose job is to look after shareholders’ interests, including keeping an eye on the manager.
The key feature is that investment trusts are closed-ended. That means they usually have a fixed number of shares in issue. If you want to buy in, you typically buy shares from another investor on the stock market rather than the trust creating new ones for you. When you sell, another investor buys them from you.
The UK’s oldest investment trust, now known as F&C Investment Trust, was founded in 1868, which gives a sense of how long the structure has been around.
Discounts and premiums
Because the share price is set by buyers and sellers on the market, it does not always match the value of the trust’s underlying investments. That underlying value is called the net asset value, or NAV, per share.
- If the share price is below NAV, the trust is said to trade at a discount.
- If the share price is above NAV, it trades at a premium.
As a purely illustrative example, if a trust’s investments are worth £1.00 per share but its shares trade at 90p, it is at a 10 per cent discount. Discounts can widen when investors are nervous or a sector is out of favour, and narrow when sentiment improves. This adds an extra layer of movement on top of the performance of the investments themselves.
Gearing
Investment trusts are allowed to borrow money to invest, which is known as gearing. In a rising market, gearing can boost returns because the trust has more invested. In a falling market, it magnifies losses. Trusts publish their gearing levels, usually as a percentage of net assets, so it is worth checking how much a trust has borrowed before you buy.
How they compare with other funds
Open-ended funds, such as unit trusts and many ETFs, create and cancel units as investors come and go, so their price generally tracks the value of their holdings closely. Investment trusts do not do this, which is why discounts and premiums exist.
The closed-ended structure has some advantages. Because managers do not have to sell holdings when investors want their money back, trusts can hold less liquid assets, such as property, private companies or infrastructure projects. Trusts can also keep back some income in good years to help support dividends in leaner ones.
Many investment trusts are listed in the FTSE 250, covered in our guide to the FTSE 250.
Costs and other points
Investment trusts charge annual management fees, which are shown in their published cost figures. Buying their shares also usually attracts UK stamp duty, as explained in our earlier guide on stamp duty on UK shares, and you pay dealing charges and the spread between buying and selling prices.
Smaller trusts can be less liquid, meaning wider spreads and harder trading in large sizes.
Common mistakes to avoid
- Assuming a wide discount is automatically a bargain. It may reflect real concerns about the portfolio or manager.
- Ignoring gearing, which can make a trust more volatile than its holdings suggest.
- Comparing performance without checking whether figures use share price or NAV.
Bringing it together
An investment trust is a listed company that invests in a portfolio of assets on behalf of its shareholders. Its closed-ended structure means shares can trade at a discount or premium to their underlying value, and it can borrow to invest. Understanding those features helps explain why trust shares sometimes move differently from the assets they hold.
If you would like to check how well you understand different investment structures, take our free trader assessment.
