Prime Time Financial

There is no shortage of investment funds for investors to choose from. Firstly, there are around 2,500 unit trust funds (or "open ended investment companies" - OEICs) which many investors are familiar with. Other investors are more familiar with the slightly smaller world of investment trusts. So what are the key characteristics of investment trusts?

In an investment trust you become a shareholder of a company set up to make investments. So your investment is in shares which, like any others,  can go up and down in value. The price of the shares is related to the assets owned by the investment company - typically shares in other companies - called the "net asset value" or NAV.

But the price of the shares could be higher or lower than the NAV depending on how investors see the prospects for the company. So the share price could be trading at a premium to the NAV (higher), or at a discount (lower).

Use With Care

Another characteristic which is a double-edged sword is the fact that investment companies can borrow money (like any other company) and can use this loan to purchase additional assets. That "gearing" is a big advantage when things are going well since it can increase the growth rate per share, but it can be a big problem when things are going badly or when management is poor.

These factors mean that investment trusts can be more volatile than unit trusts, since investor sentiment and level of gearing come into the picture as well as the value of the investment assets which the company own.

As a general rule, in a bear market (falling investment values), discounts get bigger and investment trusts have relatively more value than at other times. Conversely, in a bull market (rising values), discounts narrow and there is relatively more value in other types of investment such as unit trusts.

Advantages

Unlike unit trust funds, your money is not directly used to make investments. And therein lies one potential advantage of investment trusts. The fund manager does not have to sell underlying assets when investors want to sell their investment as they do with unit trusts. So investment trusts are easier to manage where they are invested in less liquid areas such as property or other real assets, or small company shares.

Investment trusts have a reputation of being lower cost investments. That may often be true, particularly for larger investment trusts with economies of scale, but as ever, needs looking at on a case by case basis to be sure.

Investment trusts do not have to distribute all of the income received from investments. Up to 15% of income can be retained as reserves, and used to smooth the dividends paid out to investors in later years. Because of this level of active management, some investment trusts have managed to increase the dividend they pay out each year for over 40 years, and so are very suitable for investors seeking a regular income.

Overall, investment trusts deserve a place in many portfolios, but we would recommend taking professional advice to know when!

Last reviewed 22nd March 2011