Investment Trust

Published Apr 29, 2024

Definition of Investment Trust

An investment trust is a form of collective investment found mainly in the United Kingdom. It is a public limited company designed to generate profits by investing in the shares of other companies. Shares of the investment trust itself are then traded on the stock market. This allows individuals to invest in a diversified portfolio of assets indirectly through a single share in the investment trust, providing them access to a broader range of securities than might be feasible individually.

Example

Imagine you want to invest in the technology sector but don’t have the expertise to pick individual stocks or the capital to diversify effectively. By purchasing shares in a technology-focused investment trust, you can gain exposure to a wide array of technology companies. The trust is managed by professional managers who decide which companies to invest in, when to buy, and when to sell, aiming to maximize returns for shareholders. For instance, an investment trust might include stocks from leading global tech firms like Apple, Google, and Samsung, alongside smaller, high-growth potential companies.

Why Investment Trusts Matter

Investment trusts are important for several reasons:

– Diversification: They offer investors a way to diversify their portfolio across a wide range of assets with a single investment, reducing risk.

– Professional Management: Investment trusts are managed by experienced professionals, offering investors access to expert knowledge and strategic investment decisions.

– Liquidity: Shares of investment trusts are traded on the stock exchange, providing investors with the flexibility to buy and sell shares easily.

– Growth Potential: Investment trusts can use gearing (borrowing to invest), which can enhance returns in rising markets but also increase losses if markets fall.

– Income: Many investment trusts aim to provide regular dividends, making them attractive for income-seeking investors.

Frequently Asked Questions (FAQ)

What makes investment trusts different from mutual funds or exchange-traded funds (ETFs)?

Investment trusts differ in several key ways. They are structured as companies with a fixed number of shares, meaning they can be traded at a premium or discount to the net asset value (NAV). In contrast, mutual funds are priced at NAV, and new shares are created or redeemed as investors enter or leave the fund. ETFs, like investment trusts, trade on stock exchanges but typically track an index and trade close to their NAV due to the creation and redemption mechanism. Unlike mutual funds and ETFs, investment trusts can employ gearing to enhance returns.

Can the share price of an investment trust differ from its net asset value?

Yes, the share price of an investment trust can and often does trade at a premium or discount to its net asset value (NAV). This discrepancy occurs due to supply and demand dynamics on the stock exchange where the trust’s shares are traded. A premium might indicate optimistic investor sentiment about the trust’s future prospects, while a discount could suggest skepticism or underperformance.

What are the risks associated with investment trusts?

While investment trusts can offer considerable rewards, they come with risks. Market risk affects the value of the securities within the trust’s portfolio. Gearing can amplify both gains and losses, making investment trusts potentially more volatile than non-geared funds. Additionally, trading at a discount or premium can introduce an extra layer of risk regarding the timing of buying or selling shares. Lastly, the performance of the trust relies heavily on the skill of the fund managers, introducing an element of management risk.

Investment trusts provide a unique and versatile investment vehicle for those looking to diversify their portfolio, access professional management, and potentially secure an income via dividends. However, as with all investments, individuals should carefully consider their investment objectives and the risks involved before investing in an investment trust.