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| ====== Investment Trusts ====== | ======Investment Trusts====== |
| Investment trusts (also known as 'investment companies' in the US) are the oldest and, some might argue, the cleverest form of collective investment vehicle. Imagine a company whose only business is to own shares in //other// companies. That's an investment trust. It's a publicly-listed company, meaning you can buy and sell its shares on a `[[stock exchange]]` just like you would for Apple or Microsoft. Because it's a company, it has a fixed number of shares in issue, making it a type of `[[closed-end fund]]`. This structure is fundamentally different from `[[open-end funds]]` (like `[[mutual funds]]` or `[[OEICs]]`), which create new units for new investors and cancel them when investors sell. This seemingly small difference has massive implications for the savvy investor, creating unique opportunities and risks. The first investment trust, the Foreign & Colonial Investment Trust, was launched in London in 1868 with the aim of giving "the investor of moderate means the same advantages as the large capitalists," a mission that rings true to this day. | Investment Trusts (also known as a type of [[Closed-End Fund]]) are one of the best-kept secrets in the world of investing, especially for those with a [[Value Investing]] mindset. Imagine a company whose only business is to own shares in other companies. That's an investment trust. It's a publicly-listed company, just like Apple or Microsoft, that you can buy and sell on a [[Stock Exchange]]. The trust raises a fixed pot of money from investors once, during its [[Initial Public Offering (IPO)]], and then its professional [[Fund Manager]] uses that cash to build a portfolio of investments. Because the pool of capital is fixed (or 'closed'), the manager is never forced to sell good assets at bad prices just because investors are panicking and pulling their money out. This structure gives them the freedom to think and act for the long term—a massive advantage that their more popular cousins, [[Mutual Funds]], simply don't have. They are particularly popular in the UK, but the concept exists globally. |
| ===== How Do Investment Trusts Work? ===== | ===== What Makes an Investment Trust Tick? ===== |
| An investment trust is a self-contained entity. It raises a fixed pool of capital from investors at launch through an `[[Initial Public Offering (IPO)]]`. This money is then handed to a `[[fund manager]]` who invests it in a portfolio of assets according to a specific strategy. The trust itself has an independent board of directors whose job is to represent the shareholders' interests—that's you! They oversee the fund manager, control costs, and make key strategic decisions. | At its heart, an investment trust is a company, not a fund. This distinction is crucial and is the source of all its unique features. While open-ended funds, like mutual funds, create new units for incoming investors and cancel units for those leaving, an investment trust has a fixed number of shares. |
| Because the trust's shares trade on an exchange, their price is not directly tied to the underlying value of the investments it holds. Instead, the share price is set by the simple forces of supply and demand in the market. If more people want to buy the trust's shares than sell them, the price goes up. If more want to sell, the price goes down. This creates a fascinating and crucial divergence between the share price and the actual value of the assets, leading to the concepts of discounts and premiums. | ==== The Closed-End Structure: A Fortress of Capital ==== |
| | The 'closed' pool of money is the trust's superpower. Think of it like a ship on a long voyage. The captain (the fund manager) knows exactly how many supplies (capital) they have for the entire journey. They won't suddenly have to jettison precious cargo halfway through because some passengers want to get off. |
| | This stability allows the manager to: |
| | * **Be Patient:** They can buy assets they believe are undervalued and hold them for years, waiting for their true worth to be recognised, without worrying about daily redemptions. |
| | * **Invest in Illiquid Assets:** They can invest in things that are harder to sell quickly, like commercial property or private equity, which can offer higher returns. |
| | * **Focus on Performance:** Their primary job is to grow the value of the portfolio, not manage investor flows. |
| | This structure is overseen by an independent board of directors whose job is to look after the shareholders' interests, which includes holding the fund manager to account. |
| ===== The Magic of Discounts and Premiums ===== | ===== The Magic of Discounts and Premiums ===== |
| This is where things get really interesting for a `[[value investor]]`. The separation between the share price and the underlying asset value is what sets investment trusts apart. | This is where it gets really exciting for the bargain-hunting investor. Because an investment trust’s shares trade on an exchange, their price is driven by supply and demand, just like any other stock. This price can, and often does, differ from the actual underlying value of the assets it holds. |
| ==== What is Net Asset Value (NAV)? ==== | ==== The Share Price vs. The NAV ==== |
| The `[[Net Asset Value (NAV)]]` is the "true" per-share value of the trust's holdings. Think of it as the liquidation value. It's calculated by taking the total market value of all the investments in the portfolio, subtracting any liabilities (like debt), and then dividing that figure by the total number of shares in issue. | Every trust calculates its [[Net Asset Value (NAV)]]. This is the real-time market value of all its investments, minus any debts, divided by the number of shares in issue. The NAV is the "true" value of one share. However, the price you pay on the market can be higher or lower than the NAV. |
| * **Formula:** (Total Assets - Total Liabilities) / Number of Shares = NAV per share. | * **The [[Discount]]:** When the share price is //lower// than the NAV. This is the holy grail for value investors. You are literally buying a pound's worth of assets for, say, 90 pence. This can happen if the trust's sector is out of fashion or if the manager has had a period of poor performance. |
| The NAV tells you what one share is //intrinsically worth// at a specific moment in time. | * **The [[Premium]]:** When the share price is //higher// than the NAV. You're paying more than the assets are worth. This typically happens when a manager is famous or the sector is red-hot. |
| ==== Buying a Pound for 90 Pence ==== | Buying at a significant discount offers a double-whammy return: you profit if the underlying assets go up in value, and you get an extra boost if the discount narrows or disappears over time. |
| The real opportunity arises when a trust's share price falls below its NAV. This is known as trading at a `[[discount to NAV]]`. | ===== The Gearing Advantage (and Risk) ===== |
| * **Example:** A trust has a NAV per share of £1.00. However, due to lacklustre market sentiment or a temporary fall out of favour, its shares are trading on the stock exchange for just £0.90. This means you can effectively buy £1.00 worth of underlying assets for just 90p—a 10% discount! | Another unique feature of investment trusts is their ability to use [[Gearing]] (also known as [[Leverage]]). This means the trust can borrow money to invest more than the initial capital raised from shareholders. |
| For a value investor, this is the holy grail. You're not just buying into a well-managed portfolio; you're buying it on sale. The potential for returns comes from two sources: the growth of the underlying assets (the NAV increases) and the narrowing of the discount (the share price rises closer to the NAV). | Imagine a trust has £100 million in assets from shareholders. It might borrow another £15 million, giving it a total of £115 million to invest. |
| The opposite can also happen. When a trust is very popular, its share price can rise //above// its NAV, known as trading at a `[[premium to NAV]]`. In this scenario, you'd be paying, say, £1.10 for only £1.00 worth of assets. For value investors, this is generally a signal to be cautious or look elsewhere. | * **When it works:** If that £115 million portfolio grows by 10% (to £126.5 million), the return on the original £100 million of shareholder funds is much higher than 10% (after accounting for borrowing costs). Returns are magnified. |
| ===== Key Features for the Savvy Investor ===== | * **When it backfires:** If the portfolio //falls// by 10%, the losses are also magnified. Gearing is a double-edged sword that adds risk, but in the hands of a skilled manager over the long term, it can significantly boost returns. |
| Investment trusts have a few other tricks up their sleeves that make them powerful tools. | ===== Capipedia’s Take for the Value Investor ===== |
| === Gearing (or Leverage) === | For the disciples of Benjamin Graham and [[Warren Buffett]], investment trusts are a fantastic tool. Their structure inherently promotes the long-term, patient approach that underpins all successful value investing. The ability to buy a diversified portfolio of assets managed by a professional at a discount to its real worth is a structural advantage you won't find in [[Exchange-Traded Funds (ETFs)]] or mutual funds. |
| Unlike their open-end cousins, investment trusts can borrow money to invest. This is called `[[gearing]]` (or `[[leverage]]` in the US). By borrowing at a low interest rate and investing that money for a potentially higher return, gearing can supercharge shareholder returns in a rising market. However, it's a double-edged sword. In a falling market, gearing will amplify losses, making the trust more volatile. The board of directors decides on the gearing policy, and it's a key metric to check before investing. | However, they are not a free lunch. You must do your homework. Always check: |
| === The Independent Board === | * **The Discount/Premium:** Is it trading at a historical high or low? Why? |
| Every trust has a board of directors that is legally obligated to act in the shareholders' best interests. This provides a crucial layer of oversight. A good board will hold the fund manager to account, ensure fees are reasonable, and take action if performance is poor. They can even fire the manager and hire a new one without disrupting the fund's structure—a feat impossible for a mutual fund. | * **The Gearing:** How much debt is the trust using? Are you comfortable with that level of risk? |
| === Smoother Income === | * **The Manager and Strategy:** Do you believe in the manager's long-term vision? |
| For income-seeking investors, trusts offer a unique advantage. They are allowed to hold back up to 15% of the income they receive from their investments each year. This money is placed in a `[[revenue reserve]]`. In lean years when company `[[dividends]]` are cut, the trust can dip into this reserve to "smooth" its own dividend payments to you, the shareholder. This is why many investment trusts have incredible track records of consistently increasing their dividends for decades, earning them the title of 'Dividend Heroes'. | * **The Costs:** Look at the Ongoing Charges Figure (OCF). |
| ===== The Capipedia.com Takeaway ===== | In a world obsessed with short-term noise, the humble investment trust offers a structure built for long-term sanity and success. |
| Investment trusts are a formidable weapon in an investor's arsenal. Their closed-end structure creates the potential to buy a professionally managed portfolio of assets for less than its intrinsic worth—a concept that should make any value investor's ears perk up. The ability to use gearing can enhance returns, and the revenue reserve feature provides a reliable and growing income stream for those focused on dividends. | |
| However, they are not without risk. Discounts can widen, and gearing magnifies losses just as effectively as it magnifies gains. An investment trust requires a bit more homework than a simple `[[tracker fund]]`, as you need to consider not just the portfolio but also the discount/premium, the level of gearing, and the quality of the board. For the patient, long-term investor willing to do that homework, investment trusts offer a time-tested and highly effective path to building wealth. | |
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