Investment Trusts
What is a Investment Trust?
Investment Trusts are "closed-ended". This means that they issue a fixed number of shares at their launch, and then do not subsequently buy shares back or issue new shares, except in very rare cases.
Investment Trust shares trade on a stock exchange, like an ordinary equity shares of a public company. Unless you buy in on the launch, any shares you purchase in an Investment Trust will be usually be bought over an exchange, at the prevailing market price.
So you are trading with other investors at a market price. Unlike with OEICs and Unit Trusts, you will pay commission to buy and sell Investment Trust shares, just as you would the shares of any publicly traded equity.
An Investment Trust´s market price should broadly reflect the NAV, but is ultimately based on the forces of supply and demand prevailing in the market for the trust's shares. Many Investment Trusts trade at discounts to the value of their underlying assets, while some trade at a premium; Investment Trusts trade at different market prices throughout the day.
From the asset manager´s perspective, Investment Trusts are attractive because they give the management company the ability to earn management fees on a stable pool of capital until the trust is wound up.
The format also lends itself to investments in less liquid markets and securities, since the manager will not be forced to trade because of inflows or outflows of cash.
SUMMARY
- > Investment Trusts are "closed-ended"
- > Investment Trust shares trade on a stock exchange
- > Shares are traded at market price
- > A comission is paid to buy and sell Investment Trusts
- > There is no gearing limit in Investment Trusts
Investment Trusts and Gearing
Investment Trusts have also traditionally been different from OEICs and Unit Trusts because of their ability to borrow money, or "gear" their portfolios. Unit Trusts and OEICs, on the other hand, have been restricted to borrowing no more than 10% of their assets. This is changing for most OEICs (but not Unit Trusts), as the EU's UCITS regulatory structure now permits funds to use financial derivatives for investment purposes. Although this doesn't alter the actual borrowing limit, it effectively gives OEICs that elect to use the UCITS structure - and most do - the ability to heavily gear their portfolios by using derivatives.
Gearing increases a fund's upside potential but also magnifies its downside risk considerably. Take for example, an Investment Trust with £100 million in assets which borrows an additional £100 million, then invests the entire sum
