Here we are at session number 70 , and we’re going to be talking about Investment Trusts. These very specific kinds of investment vehicles are neglected by many investors and advisers alike, for various reasons. But you should know about them, because they do have advantages – and risks – that other funds like Unit Trusts and OEICs do not.

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Introduction

Like I said right at the top of the show, Investments Trusts are misunderstood by many investors and perhaps more worryingly, ignored by advisers. There’s no denying why this latter is the case. Money into Investment Trusts is in the form of shares, and there is no commission on shares!

Of course, now there is no commission on anything, so there really is no excuse for ITs not to be considered as part of a balanced portfolio.

So, the usual drill: first I’ll look at what you need to know about Investment Trusts, and then what you need to do to get to know them a little better and maybe dip your toe into the investing water.

Remember that the show notes are the one link you need to remember. There’s a transcript and all the links you need are there. Meanningfulmoney.tv/session70

Everything you need to KNOW

So, let's deal first with everything you need to know about Investment Trusts

1 – An investment trust is not a trust; it’s a company

This might seem disingenuous, but it’s true! An Investment Trust is a limited company, and you buy shares in it, just as you would for Vodafone, Marks and Sparks or whoever. That’s as opposed to an Open-Ended Investment Company (OEIC) which is not really a company in the true sense! So an investment trust is a company, and an OEIC company is not a company, Whoever said personal finance was confusing?!

Be that as it may, you buy shares, and not units, in an Investment Trust.

Like all companies, Investment Trusts are closed-ended, not open-ended like OEICs. In practice this means that there are a finite number of shares in existence. Once the Investment Trust raises the money it needs when it launches, it issues the fixed number of shares to its investors. Anyone new looking to invest in the Investment Trust can only do so if there is someone else looking to sell.

An OEIC or Unit Trust, by contrast, can create more units if more people are looking to invest, or can destroy units when people withdraw their money.

This means that the managers of an Investment Trust can take a longer term view because there is never any need to sell assets, just to cover withdrawals. This is an important benefit to my mind.

Like all shares, there are two ways to buy: either form the company itself when it is starting up, or from a broker or platform.

2 – Benefits of Investment Trusts

Like all collective investment vehicles, including OEICs and Unit Trusts, the key benefit of investing in an Investment Trust is the pooling of your money with other investors to provide economies and opportunities of scale. Having more money to play with means the fund managers can take advantages of better and more investing opportunities, at lower cost, than you could on your own.

Another benefit is the separation of the board of the investment trust and the manager. Managers move around all the time as they are poached by one company from another, or if they set up on their own, like the famous Neil Woodford has just done.

Remember again that an Investment Trust is a company, run by a board of directors. These directors can hire and fire a manager to run the portfolio. The manager is usually from another investment house, but is brought in to manage the Investment Trust’s money. It’s a consulting arrangement almost. This has the advantage that investment Trusts have very few employees. Instead, the fund manager and his or her company have the analysts and other staff costs to bear. The Investment Trust pays a fee to the manager and that’s it. The key benefit is that if employee costs are low, the fund management fees can also be kept low.

3 – Net Asset Value, Premium and Discount

The total value of all the assets held by an Investment Trust is called its Net Asset Value. If you sold everything owned by the trust and divided that figure by the total number of shares in existence, this is the price you would have.

But Investment Trust shares are traded on the stock market, which means the fickle influence of investor sentiment comes into play. So if investors think that the value of the Trust is going to rise, chances are the price of its shares will rise higher than the total value of its assets. This is called trading at a premium.

If on the other hand, investors are concerned about the future prospects of the trust, they may sell off their shares, causing the price to fall. If this drops below that of the Net Asset Value, the shares are said to be trading at a discount.

This must be factored into any decision to buy into an Investment Trust. Shares trading at a discount are cheap relative to the value of the assets within the trust, and so would seem to represent a bargain. But they are at a discount because investor sentiment is generally negative, so should you buy in?

Things to think about…

4 – Gearing

The last thing you need to know about Investment Trusts is that they can borrow money to invest, in a process called gearing. Doing so means that gains made int eh market can be amplified, but so can the losses.

Let’s say you have £1000 to invest and you borrow another £500 to invest on top of that. The assets you buy double in price, so your £1,500 doubles to £3,000. If you pay back the £500 you borrowed, plus some interest and fees (say £50) and you have £2,450, rather than just the £2,000 you would have had if you hadn’t borrowed the money.

Conversely, if the £1,500 you invested halves to £750, and then you pay back the £550 loan plus fees, then you’re left with £200 instead of the £500 you would have if you hadn’t borrowed.

So gearing means that Investment Trusts can do better than OEICs and similar funds when markets are rising, but can be hit harder when markets are tough. This adds volatility, a key measure of risk into the investing equation.

Summarise KNOW

#1 – An Investment Trust is a company

#2 – There are clear benefits to investing in them

#3 – Their shares can trade at both a premium and a discount

#4 – They can borrow to invest

Everything you need to DO 

Knowing these things about Investment Trusts then, what do you need to DO with that knowledge?

1 – Understand Investment Trusts and how they might form part of a portfolio

The first thing is to continue your education. You need to know more and do more research into this than just listening to this 30 minute podcast! This is a great start though…!

I usually preach the merits of passive investing here, but in the interests of balance, Investment Trusts are a good compromise if you can find a good one. They have the benefits (and drawbacks) of active investing but at lower costs than OIECs and Unit Trusts. I wouldn’t counsel putting a large proportion of your portfolio into ITs, but you could consider them as a satellite holding around a passive core.

2 – Do your research

I found a useful little infographic from Morningstar, though it pains me to say that I found it on ThisIsMoney. They have five pillars, or rules for choosing an Investment Trust. Rather than nick their content, I’ll encourage you to go to the show notes and follow the link.

There are only 400 or so investment trusts to choose from, as opposed to well over 2000 open-ended funds, so that gives you something of a head start!

Use sites like FE Trustnet, Morningstar, plus the research tools available on your platform of choice, to do some research based on the five pillars in that inforgraphic.

Oh, what the hell. The five pillars are:

• People
• Culture
• Process
• Performance
• Fees

Check the infographic for a little more detail

3 – Know your limits – core and satellite?

I mentioned this briefly just now. Whenever you’re discovering a new and exciting method of investing, it can be tempting to take a decent size position but I suggest you don’t do this.

I like a core and satellite approach to investing, where the core looks after itself and drives the bulk of the portfolio performance. The core is also risk-managed and should be relatively predictable and, dare I say it, boring. The satellite holdings around the side is the fun stuff, so only do this with money you can afford to lose. Remember that Investment Trusts are more volatile as a rule, than their open-ended counterparts, so bear that in mind.

4 – Make sure your platform can handle Investment Trusts

The last thing to consider at this early stage, if you fancy investing using Investment Trusts, is to make sure you are investing using a platform that can handle them. Some of the older platforms, really fund supermarkets, can’t handle direct shares, including investment trusts very well. Again, the reason this is the case is commission, as many of these older platforms get paid from kickbacks from funds (at least, they will until April 2016, when this practice will be banned). Investment Trusts don’t give kickbacks or pay commission so the platforms don’t carry them.

The more modern platforms do though, of course, but be careful of charges when buying Investment Trusts. The platforms often charge extra dealing fees for investing in shares

Summary

The long and short of this, is that there are real merits in using Investment trusts as part of your portfolio. Like all things, if you are aware of the risks as well as the benefits, then use them. Don’t use ignorance as an excuse. If you’re serious about investing, then educate yourself (kudos for listening to this podcast!) and then take action!

This week’s reviews

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News

No weight loss this week I’m afraid. A relative’s 60^th birthday put paid to that, but I’m hoping for good things this coming week. Still want to get down to 15 stone-something before my holiday in three weeks’ time.

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Next Session Announcement

Next time we'll be talking about Keeping your head in a financial crisis. If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/askpete

Outro

That's it for this session of the MM podcast, I hope it was helpful. If I missed anything or if you have any questions, please leave them comments section below.