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Investment Trusts

 
Investment trusts are companies that invest in the shares of other companies.
 
They pool investors' money and employ a professional fund manager to invest in the shares of a wider range of companies than most people could practically invest in themselves. This way even people with small amounts of money can gain exposure to a diversified and professionally run portfolio of shares, spreading the risk of stockmarket investment.
 
There are over 300 investment trusts responsible for the management of billions of pounds' worth of assets on behalf of investors.
 
The main difference between Unit Trusts and Investment Trusts is that Investment Trusts are themselves Limited Companies that are traded on the Stock Exchange like any other company.
 
The other major (and very important) difference is that IT’s are allowed to ‘gear’ – i.e. borrow money to purchase additional investments. Unit Trusts are not allowed to do this (except in limited circumstances to maintain the cashflow and liquidity of the fund). If a trust “gears up” and then markets rise and the returns outstrip the costs of borrowing, the return to the investor will be even greater. But there is a downside to gearing too. If markets fall and performance of the assets in the portfolio is poor, then losses suffered by the investor will be increased due to the costs of borrowing.
 
Investment Trusts can be more specialist in Unit Trusts that are generally restricted by their sector as to what they can invest in. IT’s face very few restrictions of this kind. The universe of Investment Trust funds is more diverse than that of their Unit Trust cousins, as it encompasses Trusts that invest in areas such as Venture Capital, Alternative Energy and Tea Plantations.
 
Another difference is that like other companies shares, warrants can be issued. Warrants give the buyer the right, but not the obligation, to buy an underlying asset at a pre-determined price (strike or exercise price) on or before a pre-determined date (expiry or exercise date). Warrants can be traded just like shares, but tend to be more volatile and can expire worthless if not exercised or sold. Because of gearing, the price of a warrant can change rapidly.
 
Investment Trusts are often seen as ‘riskier’ than Unit Trusts, especially due to recent bad publicity about ‘split-capital’ trusts, but as a group, they represent a diverse range of funds catering for a range of risk profiles.
 

Discounts and premiums

 
The value of the shares you own in an investment trust is affected by both the value of the shares owned by the trust in other companies and by the level of demand for shares in the investment trust. Shares in a well managed trust are likely to be subject to higher demand which will increase the share price. If the value of the assets falls below the total value of all the trust's shares, the trust is said to be trading at a discount. If the value of the assets rises above the total value of all the trust's shares, the trust is said to be trading at a premium. If you buy when shares are at a discount, the discount could narrow, increasing your returns, or grow, eroding your returns. If you buy at a premium, it could narrow, reducing your returns or grow, increasing your returns. So you should consider discounts and premiums when considering what level of risk you feel comfortable with.
 

Taxation

 
Being a share, a dividend is deemed to have been taxed at the basic rate before being received by the investor. While basic rate taxpayers have no further tax liability, higher rate taxpayers pay an additional tax charge. See the Tax Tables to check the current rates. If you sell your shares, a liabity for Capital Gains Tax could arise if you have made a gain above the capital gains tax threshold.
 
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.
 
 
 

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