Investment Trusts

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Investment Trusts

Investment trusts are companies that are quoted on the stock market. Their business is managing funds invested in shares and other assets. You invest by buying the shares of the investment trust. There are different types of investment trust, specialising in different areas of investment, in much the same way as unit trusts. However, there are some important differences between unit trusts and investment trusts:

• Unit trusts are open-ended, meaning that when there are more people wanting to invest than to cash in, new units are created, expanding the size of the trust, and this new money is used to buy further investments in the fund. By contrast, investment trusts are closed-ended funds, because there is a finite pool of shares in the company. If more people want to buy than to sell, this drives up the share price. The unit price of a unit trust will, then, largely reflect the value of the underlying assets in the trust. However, the underlying assets are only one factor influencing the share price of an investment trust

• Investment trusts, but not unit trusts, can borrow money to invest. This has what is called a 'gearing effect', which magnifies gains on a successful investment but also magnifies losses on a poor one. Minimum investment varies from, say, £25 a month through a savings scheme run by the investment trust management company; savings schemes also accept ad hoc lump sums as small as, say, £250. Otherwise you buy through a stockbroker, and dealing charges would tend to make deals under £1,000 uneconomical.

With some investment trusts, just one class of shares will automatically give you income (in the form of dividends) and growth (if the share price rises). But 'split capital trusts' give you a choice of shares. A split capital trust is set up for a fixed period. During that time, some of its shares (the 'income shares') receive all or most of the income from the trust; when the trust is wound up, the 'capital shares' receive all or most of the growth.

There are some exotic variations on this theme: for example, zero dividend preference shares and capital indexed shares, both of which require some homework before you use them. Income shares can be useful for investors seeking a high income immediately, provided they are prepared to sacrifice capital growth. Tax treatment As for direct investment in shares. Capital shares in split capital trusts can be particularly useful for higher-rate taxpayers.

As for direct investment in shares, if you buy through a stockbroker. The cost of investing is generally lower if you use a savings scheme run by many of the investment trust management companies (because they can then buy and sell in bulk and pass on cost savings to investors). There is a spread between the price at which you can buy shares and the price at which you can sell them. The management company's annual charge for its services is usually fairly low: for example around 0.5%.

There is a risk to your capital because share prices can fall as well as rise. A trust which has a high level of borrowing, i.e, it is highly geared, will tend to have a more volatile share price than a less highly geared trust. Similarly, if the trust invests in inherently more risky companies, smaller companies or emerging markets, for instance the share price can be expected to vary more widely and your risk will be greater. As with all share-based investments, you stand a good chance of keeping pace with or beating inflation. Risk rating: from six or seven upwards.

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