Investment trusts, explained
How to invest with ‘the City’s best kept secret’
We’ve been expanding our stock universe a lot and we’re planning to ramp that up even more.
As part of this, soon, you’ll see a lot more investments trusts appearing in the app, so we want to dive into what trusts are and how you can invest with them.
What are investment trusts?
An investment trust is a type of investment fund, a company that invests in multiple assets and lets you track the performance of all of them collectively.
They’ve been called “the City’s best kept secret”, as they’re efficient and often lower cost investments than mutual funds.
To take a very popular example, the Scottish Mortgage Trust has been available on Freetrade from day one and has these companies as its top 10 holdings.
Like exchange traded funds, trusts are listed on a stock exchange so shares in the trust can be bought and sold throughout the trading day. And like those funds, trusts also charge a management fee to investors.
Trusts can follow a number of investment strategies — it’s up to the manager how they decide to invest.
Popular strategies include focusing on a sector (tech, industrial companies), a specific country or an asset class (properties, stocks).
Trusts can be passive trackers or actively managed — but they’re more often active.
However, what makes a trust unique is that it’s a closed ended fund.
This is the most important distinction of an investment trust.
Both mutual funds and ETFs are open ended funds. When new investors want to put their money in, the fund automatically creates new shares to meet that demand and invests their new money into buying new underlying assets (stocks etc) held by the fund.
This means that those funds very accurately track the value of the underlying assets.
As a closed ended fund, a trust is structured as a public company with an original pool of money to invest and a finite number of shares.
When new investors buy shares in the trust, the trust doesn’t receive any more money, create any more shares or buy any more underlying assets. Instead, the investors just buy old shares from their previous owners and gain an ownership stake in company with its original pool of investments.
So a trust:
- Doesn’t accept new investment capital
- Has a finite number of shares
- Trades on an exchange
These aspects mean that the market price of the trust can diverge from the value of its own investments — or net asset value.
Net Asset Value
Net asset value (or NAV) is the market value of the underlying assets held by a fund. Because of their closed ended structure, the actual shares of a trust can be worth more (a premium) or less (a discount) than the trusts’ investments.
For example, let’s say the ‘Only Buy Google’ trust originally raises money to buy 1,000,000 shares of Alphabet Inc. At that moment, the value of the trust will be equivalent to 1,000,000 Alphabet Shares.
However, once investors start buying and selling the shares in the trust, the value of the trust can move higher or lower than its actual investments, especially if investors have strong opinions on the the skills of the investment manager.
The percentage difference between the value of the trust and the value of the assets is known as the premium or discount to net asset value.
There is some self-correction here as investors’ own good sense would stop them from buying into trusts that have ridiculously high premiums. Demand would fall and prices would drop.
However, trusts can still trade at fairly significant differences to their net asset value — 5–10% is not too unusual.
So, always check the NAV of an investment trust to know the market value of the investments!
So, what are the benefits?
As above, investment trusts have been called the best kept secret in investing and their unique structure gives them a few interesting advantages.
- Potentially lower fees
- Managed with more freedom
- Wide variety and international exposure
- Investing at a discount
Because of their simple structure, closed ended funds incur less internal admin and fewer trading costs than open ended ones, which means that they may charge relatively lower fees.
For instance, the actively managed Scottish Mortgage Trust charges a 0.37% annual fee on invested assets. A similar actively managed mutual fund would often charge significantly more. Of course, many passive ETFs will charge even lower fees than that.
Trusts also don’t charge any fee to invest, whereas many mutual funds do.
Managed with more freedom
Unlike mutual funds, trusts, as closed ended funds, don’t have to buy any new assets when people invest or sell them when investors cash out.
This gives the managers more freedom on when to buy and sell, which can improve their performance. It also means they have more opportunity to focus on unusual or illiquid assets, like property or unlisted companies, which can’t be sold easily.
Wide variety and international exposure
Another big benefit is their availability and variety!
There are plenty of UK-listed investment trusts following diverse strategies and focusing on unusual investments from around the world. Trusts are a great option to have either highly focused or diversified investments in specific sectors, regions or asset classes.
For instance, the Scottish Mortgage Trust offers UK investors the ability to invest in a pool including Tencent, Tesla and Amazon.
Leverage or gearing is the amount of borrowed money a fund uses to invest.
The rules on how much trusts can borrow to bulk up their investments are less stringent than for some other types of fund.
This allows trusts to make bigger investments with less capital — if those investments do well, this can increase returns.
This does also mean that if the trust’s investments underperform, the value of the trust could go down even more sharply.
It’s definitely worth checking the amount of leverage a trust has before investing. A gearing of 110% would mean the fund had borrowed 10% extra money on top of its original pool to invest.
Investing at a discount
Finally, some investors appreciate the opportunity to buy into trusts which have a discount on the net value of the underlying investments.
Just be aware that the discount may reflect the market’s doubt on the manager’s abilities. 🤔
Trusts on Freetrade
You can already invest in over 30 trusts on Freetrade, including:
- Scottish Mortgage Trust
A huge trust currently focused on global tech stocks and features in the FTSE 100.
- City of London Investment Trust
This trust currently focuses on large UK companies.
- Scottish Investment Trust
This trust currently focuses on a blend of global companies from different sectors.
- Blackrock Smaller Companies Trust
This trust currently focuses on smaller UK companies.
- Edinburgh Dragon Trust
This trust currently focuses on Far East companies.
- JP Morgan Indian Trust
This trust currently focuses on Indian companies.
- Baillie Gifford Japan Trust
This trust currently focuses on medium to small Japanese companies.
- Woodford Patient Capital Trust
This trust currently focuses on long-term investments and is the world’s leading investor in low energy nuclear reaction tech.
Those are the main facts on trusts — they’re very interesting investment vehicles. Since they’re relatively less well-known, we’ve started a Q&A thread on trusts here.
We’re planning to add every trust in the FTSE 250 that we can. If there are any other trusts you want to see on the app, head to the community to request!
We’re on a mission to bring fee-free investing to Europe and beyond. 🔥
Freetrade does not provide investment advice and individual investors should make their own decisions or seek independent advice. The value of investments can go up as well as down and you may receive back less than your original investment. Tax laws are subject to change and may vary in how they apply depending on the circumstances.
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