Financial Services > Investments > Investment Trusts

 


This was the first type of collective investment, created in the 19th century originally for people of modest means to invest in shares by pooling their money with that of other investors.


It is a publicly listed company and so investors hold shares in that business which is designed to build a diversified and professionally managed portfolio of stocks and shares.

An independent board of directors exists to make sure that the fund manager acts in the best interests of the shareholders and only makes investments that are in accordance with the stated aims and objectives of the prospectus.

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All Investment Trusts have a fixed amount of capital available to them when the company begins, and so they are known as 'closed-ended' investments.

Shares are traded on the Stock Market and so the share price at any time reflects market sentiment i.e. what a new investor would be willing to pay for the share rather than having any direct relationship to the value of assets owned by the company itself.

As you can see, this has now become relatively complex and so Investment Trusts today appeal only to more financially sophisticated investors.

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As they have evolved, Investment Trusts have offered a wider range of choice to design investment companies and different types of share to suit a wide variety of needs. Split Capital Investment Trusts were introduced in 1965 to make these lower risk investments even more attractive to a wider range of investors. They have a fixed life expectancy because they state at the outset when the stocks and shares will be sold and the proceeds distributed to the shareholders. When that winding up date arrives you can simply take the proceeds in cash, roll the entire investment into another Investment Trust offered by the same manager or consider one from a different firm altogether. If you decide to take a regular income from your Investment Trust, that income will be provided from dividends received by the Investment Trust manager. All dividends have suffered Corporation Tax and so come to individuals with a 10% income tax credit and exemption from any more Income Tax at the basic rate. When you become a higher rate Income Tax payer you have extra  Income Tax to pay calculated on the net dividend you receive.

Shares are offered in many formats but there are three more common bundles: -

a) Zero Dividend Preference shares. These are often referred to as Zeros and pay no income but are first in line to be paid out when the company is wound up. Because there is no income the growth is typically twice the amount that you would normally expect from a share.  

b) Ordinary Income shares. These pay a fixed rate of income that is roughly twice the dividend rate that you would expect from a share but have no rights to any capital growth. Because the Zeros are paid out first there is no certainty that you will get your capital back when the company is wound up.

c) Capital shares. Once the Zeros and the Ordinary Income shareholders have been paid out at the wind up of the company any remaining capital is distributed amongst the Capital shareholders. It is fair to say that this is very risky indeed and should be regarded the same as gambling.   
   

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When you withdraw a lump sum from your Investment Trust, move money from one fund into another or close the investment entirely, the gain that you have made will be subject to Capital Gains Tax and not Income Tax. This is an important distinction because every UK tax payer is allowed to make gains of £11,300 in the 2017/2018  tax-year before any Capital Gains Tax is payable making the system of Capital Gains Tax quite reasonable.

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One very important thing to remember about Investment Trusts is that they are different to other forms of collective investment because the fund manager is allowed to borrow money to increase the amount of capital available for investment.

Those borrowings are known as 'gearing' and this increases the risks associated with the investment. The level of gearing varies from one Investment Trust to another but let us consider an example to help you understand the principle.

If you invested £1,000 and the fund manager borrowed a further £1,000 at 6% interest there would be investments to the value of £2,000 working on your behalf. If those investments increase in value by just 6% you will be no better off and no worse off than if the borrowing had not been made. Should the investments rise by just 3% then you will have made no profit at all because the gain on your own money has had to be used to pay the interest on the borrowed money. When the investments do not change in value you will lose money because the interest still needs to be paid on the money that has been borrowed, but when the investments rise faster than 6% you get the profit on your own investment and the difference between the actual growth and 6% on the borrowed money too.

What this means is that the share price is far more volatile than the ordinary stock market and so when the market is falling the shares in an Investment Trust will fall further and more quickly but when it is rising the Investment Trust shares rise further and more quickly for exactly the same reason.

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There are many factors to consider before investing in an Investment Trust, including the relationship that the share price bears to the net value of assets owned by the Investment Trust company itself, because there are times when assets to the value of £1,000 can be bought for as little as £800 and so there can be compelling reasons for using this type of investment as part of your portfolio.


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