What is an investment trust?

Written by Lori Campbell on 23rd Jun 2021

What is…? A new series to help you understand the basics of the different types of investment. The first in this series, ‘What is an investment trust?,’ is sponsored by Liontrust to mark the launch of its first investment trust, Liontrust ESG Trust PLC (ESGT).

EDIT (July 2, 2021): Liontrust has announced it will not proceed with the initial public offering of ESGT. The company says that also the trust had received significant support from private investors, “overall demand has not been sufficient to meet the minimum of £100 million set out in the Prospectus.”

An investment trust is a company that is listed on the stock exchange to buy shares in other companies on behalf of its investors. It is a way of enabling private investors to pool their money with others to buy a wider range of assets than they would be able to hold on their own.

As publicly-listed companies, investment trusts must have a board of directors. This is made up of a chairman, an accountant and various directors of different skills, who ensure the fund manager fulfils their mandate and acts in the best interests of shareholders. 

Investment trusts can pay dividends, making them an attractive way of generating an ongoing income stream for their investors.

How do they work?

Investment trusts are ‘closed-ended,’ which means they raise a set amount of money only once through an initial public offering (IPO) of a fixed number of shares. When all the shares have sold, the offering is “closed” – hence, the name. This allows managers to take a longer-term view because they do not have to sell assets when investors sell their shares.

In simple terms:

  1. You buy shares in an investment trust.
  2. The money from your shares is put into one big pot, along with the money from other investors – this is called ‘the fund.’
  3. The fund is then used to buy shares and assets in other companies by the fund manager. 
  4. The value of these shares and assets can go up or down and are bought and sold by the fund manager over time. The experience and skill of the fund manager is crucial here as they determine which companies they think will perform best in the long run.
  5. You sell your shares in the investment trust for the market price (which has hopefully increased) to another investor when you are ready.

The value of shares in an investment trust will fluctuate depending on two factors: 

  1. Performance. This is the underlying value of the assets it owns. Investment trusts spread their investments across a range of assets, meaning their value is less likely to fluctuate wildly in a short period of time.
  2. Supply and demand. Investment trusts have a fixed number of shares in the market, so supply and demand can influence the cost of its shares as well as the value of its underlying assets.

When the share price is greater than the value of the assets held in the company, this is known as a ‘premium’. At a time it is less, it is known as a ‘discount’.

In contrast, other collective funds that are ‘open-ended’ – such as unit trusts and OEICSs (Open Ended Investment Companies) – grow or shrink depending on investors’ money coming in or out of them. Their value is determined solely by the value of their underlying assets.

What about performance?

Research shows that investment trusts tend to outperform comparable open-ended funds. A 2019 study by stockbroker AJ Bell found that over the long term – 10 years or more – 75 per cent of investment trusts outperformed open-ended funds investing in similar assets. A study from Cass Business School in 2018 found that investment trusts outperformed open-ended unit trusts by an average of 0.8 per cent a year. 

What are the drawbacks? 

While investment trusts can bring higher returns than their open-ended counterparts, investors don’t get this extra performance for free. 

Investment trusts can give a bumpier ride because they have the ability to borrow money to buy assets, otherwise known as ‘gearing’. This means that when they are doing well their returns can be supersized, but when their investments are falling these losses could be amplified. According to the AJ Bell study, trusts are more volatile than the equivalent fund a massive 90 per cent of the time.

Is an investment trust right for me?

Investment trusts are generally most suited to investors who are willing to take a long-term view of their money – and a little more risk. 

About the Liontrust ESG Trust

The Liontrust ESG Trust (ESGT) will invest in 25 to 35 companies around the world that it deems to be sustainable over the long term, mostly in developed markets. The trust will be managed using the firm’s ‘sustainable future’ investment process, which identifies companies “helping to create a cleaner, safer and healthier world”. 

Current trends in this sector that the trust will focus on include better resource efficiency, greater safety and resilience, and improved health.

ESGT’s portfolio will be managed by Peter Michaelis, Simon Clements and Chris Foster, who are part of Liontrust’s Sustainable Investment team. 

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