Global عربي
KSA عربي
Global عربي
Despite not being as widely known as ETFs or mutual funds, investment trusts are among the oldest forms of a collective investment vehicle.
It’s structure, makeup, and governance allow it to be a vehicle for long-term investment and wealth creation. Today, we look at what investment trusts are, their key features, how they differ from other investment vehicles, as well as their risks and benefits.
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Just as with mutual funds, unit trusts, and other open-ended investment companies, an investment trust is a pool of investor money used to buy a wide variety of assets, ranging from stocks and bonds to real estate, as well as niche areas that investors may otherwise not be able to access – such as private equity.
However, unlike with these other funds, investment trusts are structures as publicly-listed companies (technically as public limited company).
This makes investment trusts close-ended, meaning that they do not issue new shares or units. Other kinds of unit trusts are open-ended, and can issue new shares based on investor demand.
Investment trust are professionally managed by a fund manager, who select the investment strategy and the assets that the trust will invest in.
These managers are selected, overseen and held to account by an independent board of directors, who are answerable to and act in the interest of the shareholders.
The value of the investment trust’s assets is called the net asset value (NAV). It is the total market value of the assets minus the liabilities of the trust, divided by the number of outstanding shares in the trust.
The NAV is very distinct and independent from the share price of the trust. The former is really a measure of the performance of the trust, while the latter is a measure of investor and market sentiment in the trust, which could be impacted by the wider market and macro climate.
When the NAV is higher than the share price of the trust, the shares are considered in discount territory. When the NAV is trading at a lower price than the share price, the shares are said to be a premium. Investors looking to invest in a trust typically are looking to buy in at a discount and sell their shares at a premium.
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The structure of an investment trust noted above give it a number of distinct features:
- Gearing: Gearing – or leveraging – is when the trust takes on debt to maximize the size of its investments, with the aim of maximizing gains (but also maximizing risk). Gearing is sometimes a must for these trusts as they are not able to raise new capital through the issuance of new shares.
- Diversification: As with most investment entities, diversification is a crucial strategy and most investment trusts will have a highly diversified portfolio to balance risk.
- Income smoothing: Investment trusts can retain up to 15% of their income every year, which would allow them to build reserves that can be deployed in further investments, or pay-off dividends even during market downturns or when earnings fall.
- Long-term focus: By being close-ended, investment trusts can make long-term investment strategies.
By not having to issue to new shares and take on additional investors, there is very little pressure on management to succumb to short-term investor demands. Furthermore, by income smoothing, investment trusts can engage in long-term strategies while also pacifying investors with steady dividend growth over long periods of time.
- Reliable income: As stated above, income smoothing can provide investors with a steady reliable income from the trust’s dividends.
- Potential for high returns: Because of gearing, investment trusts can be used to maximize gains. While this also comes with a higher risk, these can be offset through a diversified strategy.
- Transparency and governance: By being governed by an independent board of directors and following listing rules and regulations, investment trusts follow strict rules on governance and accountability. This board is also held to account through general shareholders meetings.
- Leverage risk: As noted above, because of gearing, investment trusts run the risk of being overleveraged in a bad investment, which can maximize losses.
- Discount risk: As a publicly-traded company, investment trust shares are subject to rises and falls in the market, even though their NAV could be high.
- Market risk: And since it often invests in publicly-traded assets, their values are subject to market downturns, reducing the trust’s NAV.
- Liquidity risk: As investment trusts are often limited to their existing number of shares, and some of them being small and niche, it may be difficult sometimes for investors to find a buyer for their shares.
Read more about: Five Investment Risks Every Investor Should Know & How to Minimize Them.
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
