Investment Trusts For Beginners

A unique part of the UK investment landscape is the presence of Investment Trusts (IT). ITs are funds that invests in other companies.

How big is the IT sector? A quick glance at the FTSE 350 shows a list of about 40-50 ITs, with a market cap in excess of £40 billion. They are significant in size.

What are Investment Trusts?

Investment Trusts (IT) are funds that pool capital to invest. Sponsoring and managing these ITs are big fund management companies such as Fidelity, JP Morgan, Aberdeen etc.

Many ITs are closed-ended. This mean that the number of shares of an IT remains static for a period of time. For most ITs, you can readily trade their shares during a business day. But the bid-ask spread will probably vary depending on the size and liquidity of a trust.

For example, you subscribed to an IPO of an investment trust. Three years later you wish to sell. Most likely you will be selling the shares to other buyers at the prevailing market price and not back to the trust. The original capital stays with the trust.

Below, I show some of the biggest investment trust in the FTSE 350 sector. Their assets under management run into billions.

Top 5 Investment Trusts By Market Capitalisation (£ Billions) 

  1. Scottish Mortgage IT (SMT) – £7.3
  2. F&C Investment Trust (FCIT) £3.7
  3. RIT Capital Partners (RCP) – £3.1
  4. Alliance Trust (ATST) – £2.5
  5. Templeton EM Trust (TEM) – £2.0


Five Things To Look For in an Investment Trust

  1. Investment objective of the trust
  2. Ratings
  3. NAV (premium/discount)
  4. Leverage
  5. Charges

What is Aim of the Investment Trust?

The first thing to find out about an IT is: What does it do?

One of the largest ITs in the UK, the Scottish Mortgage Trust (SMT), states this investment objective in its factsheet: “Scottish Mortgage is an actively managed, low cost investment trust, investing in a high conviction, global portfolio of companies with the aim of maximising its total return to its shareholders over the long term.

In other words, SMT invests in global securities and is unconstrained by geographical limits. Because it invested in US FAANGS stocks, it outperformed FTSE by a wide margin (see below).

Other trusts may have a more narrow focus, such as capitalisation-, sector-, or country-based. For example, the Fidelity China Special Situations (FCSS) invests solely in chinese-related securities while City of London (CTY) focuses on UK stocks.

Make sure you understand what the trust is trying to do – and its suitability to your own investment goals.

Investment Trust Ratings

Once you narrow down a list of ITs to invest, how do you evaluate and compare them? There are specialist companies that do that for you, such as Morningstar. It has a rating system with one to five-star ranking. Choose the better ones. Find out more about Morningstar’s five-star rating system here.

Premium or Discount to Net Asset Value (NAV)?

When a security is listed on the market, it will be subjected to the ebb and flow of investor sentiment. During a ‘hot’ period (mania), investors will flock into that investment theme regardless of risk. A listed investment trust will be subjected to such fad.

If the recent performance of an IT is good, investors may overbid the trust’s shares, thus pushing the value of the shares above the trust’s Net Asset Value (NAV). This is called a premium. On the contrary, when the value of the shares are lower than a fund’s NAV, it means prices are trading at a discount.

SMT, for example, published its latest NAV at 483p but its shares are changing hands at 499p. It is trading at a 3.3% premium.

In contrast, the £2-billion Templeton Emerging Market Trust (TEM) is trading at a wide 9% discount to its NAV. This shows that investors are not viewing emerging markets positively (link).

Apart from investor sentiment, there are other factors that could impact the premium/discount level. One such factor is the valuation of a trust’s portfolio. If, for instance, a trust holds many unquoted securities in its portfolio, then investors may price in a wider discount.

Investment Trust Leverage

An IT can borrow to invest to juice up returns.

For SMT, its total borrowings at the end of 2018 was about £750 million, around 10% of its assets. For Witan Investment Trust (WTAN), its gearing is higher at about 18%. Usually there is a ceiling on how much a trust can borrow (risk limits).

Leverage, however, is a double-edged sword. When an IT borrows money, it may inject more price volatility into its asset value. Second, the interest cost of this borrowing may eat into the fund’s investment returns. Therefore, I would be wary of buying an IT with high gearing ratios.

Investment Trust Charges

Running an IT is costly. So an IT would extract a fee from the trust assets to cover this cost. Bear in mind that this fee will vary. For example, F&C IT incurs a 0.5% total expense ratio while TEM imposes a 1%. Avoid ITs with high fees because this will penalise investment returns.

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Investment Advice Disclaimer

ALL INVESTING CONTAIN RISK: The information contained in this website is for informational purposes only and does not constitute financial advice. The material does not contain (and should not be construed as containing) investment advice or an investment recommendation, or, an offer of or solicitation for, a transaction in any financial instrument. Always seeking independent financial advice.