So to start with can I just say that investment trusts are one of my favourite forms of investment. They’re what my wife and I started out investing in and to this day still more than half of our portfolio is spread across various investment trusts.
So what actually is an investment trust? An investment trust is a collective investment that pools funds from many investors and then that pool is invested into various assets, which are often stocks, but can also be bonds, real estate & many other forms of assets. This has multiple benefits and also a few cons, as every form of investment does. One of the main benefits from my point of view is that it’s great if you want to have exposure to a certain sector or industry that you don’t have knowledge of, or that it might be quite difficult for you to access.
For example one of the funds that I hold is a real estate Investment Trust specialising in commercial property across Europe. I’m not going to go out there and buy warehouses or research all of the commercial real estate stocks across Europe. But this Investment Trust is managed by people that are experts in this sector & allows me exposure to a diversified portfolio of assets in that sector with the click of a button. You could say the same for all kinds of sectors. I’ve held shares in Biotech & Cyber Security Investment Trusts in the past. These are areas I had little knowledge of, but I thought it would be good to have some level of exposure to them, so investment trusts to the rescue!
Similarly another benefit to Investment Trusts is that they can go out and purchase stakes in private companies. Companies that aren’t on stock exchanges, that a normal person such as myself wouldn’t have access to in any other way. Because they’re pooling capital from many different investors they’ve got a lot of money to work with and they can approach private companies that are looking for funding or that are looking for early stage investment and they can invest on our behalf. So for example Scottish mortgage is an investment trust we have shares in. It hasn’t been doing very well for the past couple of years, but one of the things I like about them is they have investments in private companies.
Just one more. You could use it to diversify your investment portfolio by geography. I hold individual stocks in the UK and the USA but I’m not prepared to spend the time researching stocks in Asia or other parts of the world, so I have shares in an investment trust whose specialty is Emerging Markets. They have investments in companies in South America, Asia, Africa, all of the places where there’s a huge potential for growth, but with the risks associated with developing countries.
How Do They Work?
Investment trusts are closed ended funds, which means they have a fixed number of shares, much the same as a single stock would have on the stock market. Such as Google or Apple. They can increase this number though they tend to stay fairly level and this means they trade exactly like a normal stock. You buy them on the stock market, you can see the share price going up and down and you can sell them just like you would a normal stock, through your broker as you normally would.
They will have their own board of directors exactly like any other stock would, who are there to keep an eye on management make sure that they’re performing in the best interest of the shareholders.
Most investment trusts will pay out a dividend which can be great for long-term compounding and building wealth over the long term. There’s many investment trusts who have a very long track record of increasing dividend every year, so they can be great for income Seekers and those that are looking to grow their portfolio over a long period of time.
One point that I really like about investment trusts is that they can trade at a discount or premium to the net asset value of their Holdings. Now how does this happen? Well the price of an investment trust is dictated by the market, just like a normal stock, so may not reflect the current value of the basket of stocks making up the portfolio. At times an investment trust may be selling at a 15% discount to the underlying value of it’s assets, or by contrast at a premium. It all depends on the mood of the market. This provides opportunities to pick up shares at a lower price through an investment trust than if you bought them all individually. As long as you time it correctly. The discount or premium is always clearly stated on the information page on your broker platform, as well as on the companies own website.
What Are The Downsides?
Right, so I’ve rattled off a lot of positives, what about the negatives? Well the main one is that they charge a management fee for holding them. This is to pay the fund managers that are doing the research and buying & selling the stocks in the trusts. Investment trusts are a business like any other and they need to make money, your fee is how they do that. This fee can vary wildly so it’s definitely something to look at when making your decision. Sometimes it’s simply a flat fee, though often there are performance fees as well, where if the share price does really well you’ll pay more in fees. Think of this as a bonus for the fund managers, whether it’s always deserved is a debate for another time. For me personally I won’t invest if the fee is over 1%, unless it’s a very special situation and intended as a short term trade. Ideally I would like the fee to be a lot lower than that though.
Another is that while diversification protects from large losses, it also limits the upside. Consider looking at the number of holdings an investment trust has, if it’s hundreds you may as well just purchase an index tracker, as they are very unlikely to beat the market and the fees associated with an index tracker are far lower. A trust with only 50 holdings is far more likely to be able to outperform the market.
On the point of beating the market, many fund managers don’t beat the market. So it’s important to look at their past performance and go with managers that you believe have the ability and strategy to beat the markets going forward. You can find information about the fund managers and their strategies on the companies website.
Conclusion.
Now this is not advice, but I think investment trusts are a great place to start if you are new to investing. It’s where I started and it’s great because you’re not taking too much risk, you’re buying directly into a pre diversified portfolio. The process of buying is also exactly the same as buying an individual stock, so you can get used to that process and how to deal with your broker, before moving on to individual stocks, if that’s what you want to do.
As I said at the beginning, we still own a sizable portfolio of investment trusts, covering sectors and geographies that I’m not targeting through my individual investments. I am starting to trade slightly more in and out of these to move with the flow of the markets. Though simply buying and holding with regular top ups is considered by many to be an excellent long term strategy.
Okay so that was a quick introduction to investment trusts. I hope it helped shed a bit of light on the subject. For me they are a great addition to our investment portfolio. I’ll definitely do a post in the future running through our portfolio of investment trusts and how I choose which ones to buy.