Investment trusts were designed to give individual investors more bang for their buck, and have a history of delivering higher returns at lower cost.
Read on to find eight reasons I like investment trusts, and the secret weapons they have up their sleeves:
1. Spread risk
Investment trusts, like more popular unit trusts, are a type of ‘collective’ investment or ‘pooled’ fund.
This just means that they combine money from lots of investors and spread it across lots of investments – whether shares in companies, bonds, property or other assets.
Personally, I’m not confident selecting shares in individual companies. Even solid-sounding high street names can come crashing to the ground. I worry that I’d invest in an ill-fated Northern Rock, just before the credit crash, or a Volkswagen, just before the emissions scandal.
Instead, I prefer to use pooled funds, and pay a professional fund manager to do the hard work picking and choosing for me. My small stake gets invested in many more holdings than I could afford on my own. This means I won’t be hit so hard by the failure of any single company. Add international funds, and I’ll be less affected by crises in any particular country either.
2. Long track record
I prefer investments with a long track record of surviving whatever recessions, wars and stock market crashes can throw at them. Past performance is no guarantee for the future, but I’m reluctant to hand my money to a wet-behind-the-ears start up.
Luckily, the investment trust sector includes many long-established funds, including 23 that have succeeded for more than a century.
Investment trusts are actually the oldest form of collective investment. The first investment trust – Foreign & Colonial – was specifically designed for mere mortals like me, ‘to provide the investor of moderate means the same advantage as the large capitalist’.
3. Higher returns, lower costs
Investment trusts often deliver higher returns, at lower costs, than unit trusts. Investment trusts are sometimes described as the City’s best kept secret – perhaps because they have never paid commission so financial advisers would recommend them.
As always, the caveat for both unit and investment trusts is that this track record doesn’t guarantee future performance. They can fall as well as rise and you may not get back your original investment.
However, investors can keep a close eye on costs. Many investment trusts have very competitive annual charges. City of London investment trust, for example, has the lowest charges in its sector at just 0.42% a year, which compares favourably against other actively managed funds.
4. Snap up shares at a discount
Investment trusts are themselves companies that are listed on the stock market.
You invest by buying shares, and the share price goes up and down depending on the popularity of the company.
The value of your investment therefore changes with the share price – so unlike unit trusts, it isn’t directly linked to the value of the assets owned by the investment trust.
When the value of the shares in an investment trust tots up to less than the value of the assets it holds, the shares are known as trading at a discount. If the shares are worth more than the assets, it trades at a premium.
Buying shares at a discount makes me feel like I’m getting more assets for my money, although over the long term it doesn’t make a massive difference to your investment return.
5. Invest for the long term
The share structure mean investment trusts can take a long term view.
If people rush to sell shares, the share price might fall, but managers are not forced to sell investments at what could be a bad time. In contrast, a unit trust would have to sell assets if loads of investors wanted to cash in their units.
Investment trusts therefore have an advantage when investing in things that are harder to sell in a hurry – like commercial property such as hospitals, offices and factories, or companies that are not quoted on the stock market.
6. Pay more predictable income
Investment trusts have the power to pay smoother, more predictable income than unit trusts. This is because they are allowed to hold back up to 15% of returns in good years, to be paid out as dividends when times are tough.
In fact, more than 21 investment trusts have increased their dividend pay outs for more than 20 years in a row. Four investment trusts – City of London, Bankers, Alliance Trust and Caledonia Investments – have actually paid rising dividends for 50 years or more.
You can find a list of these ‘dividend heroes’ on the Association of Investment Companies website.
The income is not guaranteed. However, any investment trust that has such a long record of paying increasing dividends will be reluctant to break it.
7. Boost returns with borrowing
Investment trusts also have the secret weapon that they can borrow money to invest, known as gearing. The idea is to make more money from the money than the cost of borrowing it.
Borrowing is great when times are good, because it can boost your returns. Managers also have the chance to raise cash quickly, to seize attractive opportunities. However, if markets fall or investments fail, borrowing can make losses worse.
In practice, trusts take different approaches, so check the gearing on specific trusts before diving in. As at 31 October 2017, the average level of gearing across all trusts is only around 5.5%, according to investment analysts Morningstar.
8. Overseen by an independent board
Investment trusts have a board of directors, which appoints a manager to do the actual investing.
The board is meant to ensure the investment trust is run in the best interests of the shareholders – and the shareholders are investors like you and me.
I like the idea that the directors are working on my behalf, to squeeze fees, check on the fund manager’s performance and replace the manager if necessary.
Faith Archer is an award-winning personal finance journalist and also a money blogger at Much More With Less