Trusts offer a convenient way for people to invest in a broad range of assets, but they can be difficult for new investors to get their heads around at first.
They are similar to funds, which we covered previously in our first-time investors series, but have their own unique features that benefit investors.
Just like funds, they are run by a manager who selects which assets are included in the portfolio. When an investor puts their money into that trust, they have exposure to all the holdings that make up the portfolio.
This is far easier than hand-picking stocks and bonds yourself – investing in individual assets requires a lot of research and expertise that casual investors rarely have the time or experience for.
So far, this works just the same as a fund, but what happens to your money when you put it in a trust is very different.
A trust is a publicly listed company, so investors can buy a share in it just like any other business on the market – that is why they are often referred to as investment companies.
Therefore, when you invest in a trust, you are buying a share in that company. When you invest in a fund, on the other hand, your money goes straight into the pool of money that makes up that fund.
All of the money that is put into a fund is invested into its assets. For example, if five people put £100 each into a new fund, that fund would invest £500 split across all of the assets in the portfolio.
Similarly, when you remove money from a fund, that comes straight out of the total amount of invested money in the fund. The manager would have to sell out of assets to return that money to the investor, which can have a negative effect on the overall performance of the fund.
Because a trust is its own company it instead issues shares and any money added or removed does not impact the overall amount invested. This gives trusts a lot more freedom to invest without the manager having to worry about people potentially asking for their money back. It also means that the price can vary, as to buy these shares, investors must first find a seller.
This means that, while a fund’s return is driven purely by the assets it holds, a trust can be propelled by the supply and demand of its shares, just like any other publicly listed company.
People can add as much money as they want to a fund, but there are a finite number of shares in a trust unless it issues more. That is why you will often hear funds referred to as open-ended and trusts described as closed-ended.
Investors can work out how attractively valued a trust is by comparing its share price to the overall amount of money it has invested in assets – this is called the net asset value (NAV) and has an important role to play in judging how investable a trust is.
If a trust is undesirable, either due to the poor performance of its assets or an overall lack of interest for its sector, the value of its shares may dip below the NAV.
When this happens, it is selling at a discount, and it is worked out as a percentage of the NAV. If the shares of a trust are worth 5% less than the NAV, you would say that it is selling at a 5% discount.
Likewise, the share price can rise above the NAV when a trust is popular – this is called a premium.
Another aspect of a trust that differentiates it from a fund is its board. This is a group of people voted in by shareholders to represent the everyone invested in the trust.
Collectively, they are the main decisionmakers of the trust and while they do not choose which assets are held in the portfolio, one of their main roles is to hold the manager accountable.
The idea of this is to oversee the management of the trust and ensure the investment decisions of the manager are aligned with shareholders.
Another key attributes is gearing, which is when a fund takes out a loan to increase the amount of money it can invest. This can be a standard part of a trust, or can be increased and decreased tactically depending on how bullish or bearish the manager is on the market. As such, some funds can invest more than 100% of the money it has from investors.
However, as this is a loan, there are charges and managers will need to make more money from the investments than they are being charged in interest.
Gearing is a key function for many investment trusts, but not all use it and therefore investors should check to make sure they are comfortable with this additional risk before buying.