Investment Trust

An Investment Trust is a type of closed-end fund structured as a public company, whose shares are traded on a stock exchange just like any other business. Think of it as a company whose sole business is to own shares in other companies. Born in the UK in the 19th century, these vehicles pool money from a diverse group of investors and then a professional fund manager uses this capital to build a diversified portfolio. Unlike their more common cousins, open-end funds (such as mutual funds or OEICs), an investment trust has a fixed number of shares in issue. This simple difference is the key to its unique charms and quirks. Because the shares trade freely on the market, their price is determined by the forces of supply and demand, which means the price can swing above or below the actual value of the underlying assets it holds.

At its core, an investment trust is a Public Limited Company (PLC). When you buy into one, you are buying a share in that company, not a direct slice of the assets it owns. The company then takes all the capital raised from its shareholders and invests it according to a specific strategy—perhaps targeting global tech stocks, emerging market bonds, or commercial property. The crucial feature is its “closed-end” nature. The trust has a fixed pot of money to manage, known as permanent capital. The manager doesn't have to worry about investors pulling their money out at an inconvenient time (forcing the sale of assets) or a sudden flood of new money arriving that needs to be invested quickly. This stability allows the manager to take a genuinely long-term view, which is a massive advantage for any investor with a value investing mindset.

This is where investment trusts get really interesting for bargain hunters. The value of an investment trust's shares can detach from the value of its underlying portfolio.

• Net Asset Value (NAV): This is the “true” value of all the investments held by the trust, minus any liabilities (like debt), all divided by the number of shares in issue. It’s what one share is theoretically worth. For example, if a trust has £100 million in assets and 100 million shares, its NAV per share is £1.
• Discount: A trust is trading at a discount when its share price is lower than its NAV. Using our example, the shares might be trading on the market for just 90p. For a value investor, this is a tantalising opportunity. You are effectively buying £1 worth of assets for 90p! The hope is that this discount will “narrow” over time, giving you a bonus return on top of the performance of the underlying portfolio.
• Premium: A trust trades at a premium when its share price is higher than its NAV. In our example, the shares might be trading for £1.10. This means investors are so enthusiastic that they're willing to pay more than the assets are currently worth. Generally, value investors prefer to avoid buying at a premium.

Investment trusts have the ability to borrow money to invest, a practice known as gearing (or leverage in the US). This is a double-edged sword. By borrowing, say, an extra 10% on top of its shareholder capital, the trust can invest more money in its chosen assets. If the market goes up, the returns are magnified. For example, if a £100 million portfolio with £10 million in gearing (total investment of £110 million) rises by 10%, the gain is £11 million. This translates to an 11% gain for the original shareholders, not 10%. However, the reverse is also true. In a falling market, losses are magnified, making gearing a tool that significantly increases risk.

Here’s a quick cheat sheet to see the key differences:

• Structure:
  • Investment Trust: A closed-end company with a fixed number of shares.
  • Mutual Fund/OEIC: An open-end fund that creates and cancels units as investors buy and sell.
• Pricing:
  • Investment Trust: Share price is set by market demand and can trade at a premium or discount to NAV.
  • Mutual Fund/OEIC: Always priced and traded at its Net Asset Value (NAV).
• Manager's Life:
  • Investment Trust: Manager has a stable pot of capital and isn't forced to sell assets to meet redemptions.
  • Mutual Fund/OEIC: Manager must handle daily inflows and outflows, which can disrupt long-term strategy.
• Gearing:
  • Investment Trust: Can use gearing to potentially enhance returns (and risk).
  • Mutual Fund/OEIC: Generally cannot use gearing.

While investment trusts offer compelling advantages, they aren't a free lunch.

1. The ability to use gearing also means the potential for amplified losses.
2. A discount is no guarantee of a future profit; it can persist for years or even widen.
3. As with any investment, you must pay attention to costs. Look for the Ongoing Charges Figure (OCF), which bundles together the annual management fees and other operational expenses.

For the patient, long-term investor, the unique structure of an investment trust—especially the opportunity to buy quality assets at a discount—makes it an indispensable tool in the value investor's toolkit.