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What is an Investment Trust?

An investment trust is a type of collective (or pooled) investment and is found mainly in the UK. It is a closed-end fund and is constituted as part of a public limited company.

An investment trust is very similar to a Unit trust, though there are some key differences. For one, an investment trust manager is legally permitted to borrow capital in order to purchase shares. This allows for leverage, bringing a potential rise to investment returns...yet also increases the risk factor. Borrowing by an investment trust is called "gearing".

Investment trusts are closed ended. In other words, there is a set number of shares on offer and this stays the same no matter what number of investors there are in the trust.

In the United Kingdom, there are over 430 investment trusts with, in the middle of June 2009 over 75 billion of assets. Each investment trusts has an investment objective and differing investment areas some focus on certain sectors or countries while others invest in companies all over the planet.

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How do Investment Trusts Work?

With a similar role list as Unit trusts (see the section on Unit trusts), a fund manager will take the responsibility of the investors" pooled money. This money has been pooled via the sale of a set number of shares, which are issued by the investment trust when it launches.

The fund manager (usually delegated by the board of directors) will take that money and invest it in stocks and shares of a wide range of companies. Investment trust shares are then traded on stock exchanges.

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What is Gearing?

Investment trusts can borrow money in order to invest. This is one of the main aspects which makes an investment trust different to, say, a Unit trust. This act of borrowing is referred to as gearing. Gearing is said to improve the investments within an investment trust when they are performing well. However, when the investments are not performing so well, it is said that gearing lowers improvement.

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What is NAV (Net Asset Value)?

NAV (net asset value) is the total market value of all investments and assets of a trust minus any liabilities. So, the NAV per share is the net asset value of the trust, divided by the number of shares. The NAV of any investment trust can be viewed on a daily basis in newspapers and financial websites.

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Share Price of an Investment Trust

Each investment trust gets a share price which depends on the supply and demand for its shares within the stock market (the London Stock Exchange). The share price is either at a Discount or Premium to the net asset value (or NAV) per share.

  • When the market price of the shares is worth less than the NAV per share then the share price of the trust is at a Discount. Investors are now able to buy shares in the investment trust at less than the underlying market value of the assets within the trust.
  • When the market price of the trust"s shares are worth more than the NAV per share then the shares are at a Premium. Now, investors buying shares in the trust are doing so at a higher price than the underlying market value of the assets within the trust.

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How to Invest

For anyone who is interested in investing in an investment trust, there is a number of options available.

  • Through a stockbroker
  • Through an investment-trust company
  • Through a financial adviser
  • Through a private client manager

Most investment trust managers offer a range of ways to get involved. A straightforward way might be through a savings plan. You can choose which trust you want to invest in, and can use as little as 250 to start. Your trust manager will choose which shares to buy.

You can hold investment trusts as part of an ISA (see our section on ISAs). Holding investment trust shares in an ISA means you are exempt from Capital Gains Tax (CGT) which is an advantage.

Many investment trust managers now offer saving plans for children. These allow adults (such as parents) to invest in the long term on behalf of a child. This money could then be used to pay for school or university fees, or even a wedding or other large payment.

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There are various costs involved in investment trusts. The good news is, you can get involved with a relatively small amount of capital (see How to Invest, above).

However, investment trusts do carry administrative and/or management charges this is perfectly normal and you can compare what these are and how much is charged. There are some costs which will certainly be involved: government stamp duty is always charged and is levied by the UK government. It varies but could be around 0.5%.

Another cost which may be involved is commission. Check if this is a factor, and if so, how much is asked for. If you invest via a trust, you will not be subject to capital gains tax. Overall, the costs involved in an investment trust are often lower than investing on your own or via other investment plans. Here is the breakdown of possible cost factors:

  • Stamp Duty - always
  • Commission - possibly
  • Admin/Management fees usually (check in advance)
  • Switching/Selling charges applies to ISAs (check in advance)

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How are Investment Trusts Taxed?

An investment trust should be approved by HM Customs & Excise. As such, it is taxed on its investment income yet capital gains are not taxed. There are some rules which investment trusts must abide be in order to be approved by HM Customs & Excise, including:

  • they must be resident in the UK
  • distribute at least 85% of its income as dividends
  • make the majority of its income from investments
  • no more than 15% of its investments in any single company

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What are the Benefits of Investment Trusts?

Investing in an investment trust is one of the simplest and economical ways to invest in shares (or the stockmarket). You are exempt from capital gains tax a great advantage and the other costs involved are in many ways cheaper than in some other investment plans.

  • Wide Range of Opportunities

Using a trust also gives the investor a wider range of opportunities by pooling capital in one place, individual investors can access stocks and shares which they may not be able to reach on their own. A wide range also offers a good risk spread you are not depending on one investment to succeed.

  • Professional Investment Managers

Another key "plus" for investment trusts is the fact that your investment is in the hands of a highly trained professional investment manager. He/she has a better insight into markets and can access information which an individual investor could only dream of! For any specialist or emerging sectors, this is especially useful.

  • Low Dealing Costs

Dealing costs are relatively low in investment trusts, especially when compared to individual investors. When the manager buys and sells shares, dealing costs are paid for by the trust. They are dealing in much larger amounts of stocks and shares that a regular individual investor meaning the cost of each transaction is generally lower.

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What are the Risks?

There are many reasons to find investment trusts a low-cost, highly efficient way to invest money in the stock market. This means many investors have found that become involved over time, taking advantage of the exciting and often lucrative investment opportunities offered by investment trusts.

However, no matter where or how you intend to invest, you should be aware of risk. By placing your capital in any investment, you are also placing it at risk of loss. With regards to investment trusts, you are, despite the expert leadership of the trust, still exposing your money to the fluctuation of the stock market. Indeed, there is no guarantee that the money you invest will be made back at a profit you may not even get back your original investment.

Before entering any investment, make sure you go over the risks. If necessary, seek independent advice on your financial capabilities and suitability for the investment.

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Split Capital Investment Trusts (Splits)

A split capital investment trust is a type of investment trust. It sells different kinds of shares to investors looking for income or capital growth and runs for a fixed term.

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