Why investment trusts are useful for investors

Combining some attributes of an open-ended fund with those of a listed company, investment trusts offer plenty of opportunities for investors. If you are planning to build a portfolio made exclusively or mostly of trusts, focus on making the most of the superpowers that give them an edge over funds, while also being aware of the risks.

As with open-ended funds, investment trusts offer exposure to a range of different assets, providing diversification and active management. But unlike open-ended funds, they trade on the stock exchange at a price that can diverge from the value of the underlying assets – akin to conventional listed businesses.

As a result, trusts can be bought at a discount or a premium to their net asset value (NAV). Discounts are currently widespread, with the average for the sector standing at 6.4 per cent on 16 May. Broadly, this means that investors can pick up these portfolios at a lower price than their real value and, if the market rises, potentially bag bigger returns.

But there is no guarantee that a discount will narrow, and it may be some time before it does, so investors need to be aware it does not always equal an opportunity – as ever, things can be cheap for a reason. This pricing mechanism also generates an extra level of volatility, as trusts are exposed to market fluctuations from both their underlying assets and the performance of their shares. While open-ended funds are generally priced once a day, trusts use live pricing that changes while stock markets are open.

The investment trust structure also gives their managers additional tools that can make them more appealing to investors. These are known as gearing, revenue reserves and the ability to invest in private assets.

Gearing refers to the ability of a fund manager to borrow and invest more than the total assets of the trust. This can boost returns in rising markets but exacerbate losses if the underlying investments fall in value. A high level of gearing is generally considered a sign that a manager is feeling particularly bullish as returns have to beat the cost of debt to make leveraging a worthwhile tactic. Within the Association of Investment Companies (AIC) global sector, average gearing stood at 6 per cent on total assets as of 16 May, and the most geared trust was value investor AVI Global (AGT) at 11 per cent.

Investment trusts can also retain up to 15 per cent of the income they receive every year to build up their revenue reserves. These can then be used to pay and grow dividends, even when a trust's holdings might need to reduce their payout to shareholders. This is useful for trust investors who need a smooth income stream. Thanks to this, the likes of City of London (CTY), Bankers (BNKR) and Alliance Trust (ATST) have increased their dividends for 57 consecutive years.

Trusts can also provide access to a wider range of investments, with experts agreeing they are the best vehicle to access unlisted assets. “Having a fixed number of shares, they don't have to keep up as much [as open-ended funds] with changing demand from investors and with redemptions and inflows. Managing a fixed pool of capital means that they can go into more esoteric and less liquid areas, such as infrastructure,” says Rob Morgan, chief investment analyst at Charles Stanley. Open-ended funds have been used for private asset positions in the past, but if too many investors try to sell the fund at the same time, it can have disastrous consequences, which was the downfall of infamous investor Neil Woodford.

Trusts offer access to areas such as private equity, infrastructure and renewable energy, growth capital and property, with a decent range of specialist options for each asset class. Many equity investment trusts also aim to boost their returns by allocating a portion of their portfolios to private markets. Scottish Mortgage (SMT) is perhaps the most well-known example, with 26.2 per cent of its portfolio held in unlisted companies as of 31 March 2024. While liquidity is not as big an issue as with open-ended funds, investors should be aware that illiquid positions can make a trust a risky investment. 

Finally, investment trusts are cheaper to hold than their open-ended counterparts on some of the main investment platforms, because their listed status means they are treated like shares. For example, AJ Bell and Hargreaves Lansdown both cap their annual Isa fee for shares – at £42 and £45, respectively. However, open-ended funds tend to be cheaper or free when it comes to trading.

Read more in our 'How to use investment trusts' series

Why investment trusts are useful for investors

The trusts to buy depending on what you need    

How to pick the best investment trusts

Finding the right trusts for your portfolio

Supported by AllianzGI Investment Trusts