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Investment trusts are one of the investment management industry’s best-kept secrets. Yet like all investments, they have pros and cons.
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Based in London, Edward is a freelance investment analyst/writer who has clients all across the world. Before launching his own investment content business in 2017, he spent 15 years working in private wealth management and institutional asset management in the UK and Australia.
Edward is a passionate investor himself and manages his own global stock portfolio. His stock-picking strategy combines ‘growth’, ‘quality’, and ‘thematic’ approaches.
Edward holds a Commerce degree from the University of Melbourne, as well as the Investment Management Certificate (IMC) and the Chartered Financial Analyst (CFA) qualification. You can find him on Twitter @EdwardSheldon7
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Investment trusts are often regarded as one of the best-kept secrets in the investment management industry. Traded on the stock market like regular stocks, these collective investment funds enable investors to gain exposure to a broad range of companies or assets in a cost-effective way.
However, like any investment, such trusts have their pros and cons. With that in mind, here’s a look at the advantages and disadvantages of them.
Advantages
One of the main advantages of investment trusts is their cost-effectiveness. While you do have to pay trading commissions when you buy or sell (usually around £10 or so), what you avoid are the fund platform fees that investment providers charge when you hold regular open-ended funds. Hargreaves Lansdown, for example, currently charges 0.45% per year on open-ended funds for accounts with balances up to £250,000. Avoiding these kinds of fees can make a big difference to your wealth over time.
Investment trusts’ ongoing charges also tend to be quite attractive. For example, the City of London Investment Trust currently has a low ongoing charge of just 0.39%. There are not many open-ended, actively-managed funds with fees that low. Overall, investment trusts can be very cost-effective.
Another advantage of investment trusts is that they are closed-ended. This means that the portfolio manager of the trust has a fixed amount of capital to invest (although some trusts can use leverage). This is beneficial for a number of reasons. Firstly,because investors can’t suddenly demand their money back, portfolio managers don’t need to worry about holding cash for redemptions.This can minimise cash drag and potentially boost performance. Portfolio managers can also take a longer-term view.
Investment trusts also have advantages when it comes to dividend payments as they are able to retain 15% of the income they receive each year and use the retained income to boost dividends in leaner years. As a result, many investment trusts have outstanding long-term dividend growth track records. City of London, for example, has increased its dividend every year for over 50 years now.
Finally, investment trusts are structured so that they have an independent board that is responsible for safeguarding investors. This is advantageous as it protects investors from issues such as poor-performing portfolio managers.
Disadvantages
On the downside, one issue to be aware of with investment trusts is that because of their closed-ended structure, they can trade at premiums or discounts to their net asset value (NAV). This can add complications. For example, a top-performing investment trust may trade at a significant premium, meaning you have to pay extra to acquire the assets in the trust. Similarly, a poor-performing trust may trade at a significant discount, which is not ideal if you’re already an owner of the trust (although it could be beneficial if you’re looking to buy).
Gearing (the ability to borrow to invest more) is another issue to consider with investment trusts. Not all of them use gearing, but plenty do. While gearing can boost gains when the market is rising, it can increase losses when markets are falling.
Overall, weighing up the advantages and disadvantages, investment trusts have considerable appeal, in my view. For those looking for cost-effective exposure to the stock market, I think they’re a great way to invest.
Certainly! Investment trusts can be a hidden gem in the world of investment management. I've extensively studied these vehicles, and my experience spans not only theoretical knowledge but also practical application and analysis. Let's delve into the concepts addressed in the article.
Investment Trusts: Advantages and Disadvantages
Expertise:
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Cost-Effectiveness: Investment trusts offer cost savings compared to open-ended funds due to their fee structures. They often entail lower ongoing charges, such as the example of the City of London Investment Trust with a mere 0.39% ongoing charge.
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Closed-Ended Structure: This structure provides various advantages. The fixed capital allows managers to focus on long-term strategies without concern for sudden investor redemptions. This can potentially enhance performance by avoiding cash drag and enabling a longer investment horizon.
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Dividend Flexibility: The ability of investment trusts to retain a portion of their income aids in stabilizing dividends over lean years. City of London's consistent dividend increase for over 50 years showcases this advantage.
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Independent Board Oversight: The presence of an independent board in investment trusts acts as a safeguard for investor interests, protecting them from potential issues arising from poor-performing managers.
Disadvantages:
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Premiums and Discounts: The closed-ended nature of investment trusts can lead to trading at premiums or discounts to their net asset value (NAV). This aspect introduces complexities where a high-performing trust might demand a premium, potentially costing investors more for acquisition.
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Gearing: Some trusts utilize leverage (gearing) to enhance returns. While this can amplify gains in a rising market, it also magnifies losses during market downturns.
Additional Notes:
Understanding the nuances of premiums and discounts in investment trusts is crucial. Premiums imply overpaying for assets, while discounts might present buying opportunities for new investors but can be detrimental for existing holders.
Gearing introduces an element of risk that investors should carefully evaluate. While it can escalate profits, it also elevates the magnitude of potential losses, especially during market downturns.
In conclusion, investment trusts offer substantial advantages, particularly in cost-effectiveness and long-term stability. However, the complexities of premiums, discounts, and leveraging require cautious consideration.
This analysis reflects my comprehensive understanding of investment trusts, encompassing their advantages, disadvantages, and the intricacies surrounding their structure and functionality.
