Investment trusts

An investment trust (IT) is a form of investment fund found mostly in the United Kingdom and Japan. Investment trusts are closed-end funds, organised as publicly listed companies that invest in financial assets or the shares of other companies on behalf of their investors.

This page is an introduction for non-US investors considering investment trusts as part of their investment plan. Investment trusts have been part of the UK investment markets for many decades and are a trusted form of vehicle for many investors. Investment trusts can also be helpful in certain tax circumstances.

Background
Investors in in Japan, New Zealand and Australia regularly use investment trusts. However, this section does not deal with these in detail. It also does not contain any information on closed end funds domiciled in the US.

This article does not cover investment trusts' legal structures, governance, applicable legislation, performance history, and underlying investment philosophy. The references and links below should give you a more than adequate background to the subject.

Using investment trusts for a simple Bogleheads approach is counter-intuitive, due to the management style (active) and the ongoing costs. However, you can still consider them if they help you with diversification, simplicity, or perhaps tax optimisation. Foreign and Colonial Government Trust’s first prospectus captured the intention in the clear prose: "The object of the Trust is to give the investor of moderate means the same advantages as the large Capitalists, in diminishing the risk of investing in Foreign and Colonial Government Stocks, by spreading the investment over a number of different Stocks, and reserving a portion of the interest as a Sinking Fund to pay off the original capital"

Before investing into this type of fund though, you may want to research funds thoroughly, and perhaps also seek advice from a qualified financial adviser before making any investments.

Key points on investment trusts
When you invest in an investment trust you are buying shares in the investment trust. Its share value fluctuates based on:


 * the underlying value of the assets they own, and
 * the supply and demand for their shares

A few key observations regarding investment trusts (ITs):


 * ITs are closed end funds, meaning they have a limited number of shares. Additional shares are not normally issued, and shares are not subject to buyback.
 * Their shares trade on the stock market throughout its opening hours.
 * You pay normal commissions for investment trust share trades.
 * The share price at any time might not equal the NAV; premiums and discounts to the NAV are based upon market supply and demand.
 * ITs can use leverage, and this will increase the risk attached to the fund.
 * ITs are actively managed funds.
 * The management fees for ITs are generally higher than a passively managed index fund.

Foreign and Colonial
Foreign and Colonial is probably the most famous name in investment trusts and it is described here for that reason, rather than for any outperformance. The original company was founded in 1868 as the Foreign and Colonial Government Trust, and was the first collective investment trust in the world. It originally invested in government bonds only.

The company has approximately £4.3bn under management, with stakes in about 500 companies around the world, and is listed on the London Stock Exchange and the New Zealand stock exchange.

The Foreign and Colonial name was re-branded as F&C (FCIT), and has now been re-branded again to a range of BMO fund names with new tickers associated. Following the takeover by the Canadian asset manager BMO, the F&C funds have become part of their stable of funds and F&C is now called BMO Capital and Income Investment Trust PLC with ticker BCI.

Investment trust providers - UK
The Association of Investment Companies exists to look after the interests of investment trusts and provides a search facility for registered investment trusts.

The top ten are listed below in order of total asset value (as of July 2019):

The top ten largest global investment trust funds, excluding REITs and hedge funds, are (as of July 2019):

The numbers given above are the underlying total asset values, and differ from the NAV. The difference between the asset value and the NAV can be substantial.

Selection of investment trusts
Investment trusts are actively managed by a fund manager, who looks to various sectors and asset types to achieve the funds goals. This may let you invest in assets that may not be normally accessible. The range of funds also lets you choose particular geographies, sectors, investment styles or industries.

The manager can choose to invest in assets including:


 * Company shares
 * Property
 * Other funds
 * Debt
 * Cash

There are over 400 investment companies, many of which have existed for more than 50 years. They include:


 * Investment trusts (covered in this article)
 * Offshore investment companies
 * Venture Capital Trusts (VCTs)
 * Split capital investment companies

The Association of Investment Companies website provides information on the registered companies, including:


 * Discounts
 * Dividend payments
 * Share price and total returns
 * NAV total returns
 * Charges
 * Gearing
 * Trading volumes

The largest sectors by assets under management (UK based, as of December 2017) were:


 * Global (£27.1 billion)
 * Private Equity (£14.7 billion)
 * UK Equity Income (£12.0 billion)
 * Infrastructure (£10.0 billion)
 * Specialist Debt (£7.8 billion)

Management and performance fees
You will pay an annual management fee and other ongoing administration costs. These costs are normally offset by the income a trust receives from its investments, and the difference is distributed to the trust’s shareholders as its dividends. The full amount of these charges, known as the Ongoing Charge Figure (OCF), tends to be lower than for unit trusts and OEICs, especially for the largest investment trusts; that is, those with assets over £500m.

One reason for the lower costs is that investment trusts are not allowed to advertise themselves, which saves them money, although they are allowed to promote savings plans that let you buy their shares on a regular basis. On top of this, because they are closed-end funds, they do not have to deal with money coming into and leaving the fund, something that open-ended funds have to contend with.

Investment trusts may charge for other ‘incidental’ costs such as performance fees which are paid to the manager if they meet certain targets. Although this is not normally included within the ongoing charges figure, you can usually find this information in the Key Information Document.

Typical fee ranges
According to the AIC website:


 * Global investment trust charges range from 0.37% to 0.99%. These figures include performance fees where these are applicable.
 * Global emerging market investment trusts charges range from 0.70% to 2.70%. These figures include performance fees where these are applicable.
 * Global smaller companies investment trusts charges range from 0.81% to 1.47%. These figures include performance fees where these are applicable.
 * European smaller companies investment trusts charges range from 0.70% to 1.18%. These figures include performance fees where these are applicable.
 * JP Morgan US Smaller Companies Investment Trust fees are 1.33% including performance fees.

Investment trusts usually have smaller operating costs than open ended funds also known as OEICs (Open Ended Investment Companies) so their charges are generally lower.

Transaction and associated costs
Because investment trusts are public companies traded on the London Stock Exchange, you buy investment trust shares just as you would shares in a normal company, and therefore the charges are similar. You will pay the stockbroker’s commission on buying and selling. If you use a cheap broker or platform, this should be relatively small. In addition to the transaction commissions, you will lose a small amount because of the difference between the bid and offer prices of the shares of the trust. However, again, this tends to be a relatively small amount, especially for the largest trusts. You also have to pay stamp duty of 0.5% on purchases.

As noted below, you might find it difficult to access to investment trusts on some platforms.

Corporate level
The UK's IT regime benefits from an attractive tax regime. As a UK tax resident company, an IT is within the charge to UK corporation tax but, where approved as an IT for an accounting period, the IT is exempt from UK tax on its chargeable gains for that period. An approved IT is broadly subject to corporation tax on its income in the same way as other UK tax resident companies. However, because of the nature of its activities, the company should be treated as a company with investment business and therefore gains are tax free to the trust.

In addition, an IT is likely to be exempt from corporation tax on dividends or distributions received from its equity investments.

Investor level
You are generally subject to tax in the same way as if you held shares in an ordinary UK tax resident company.

As of April 2018, all individuals are eligible for a separate tax-free Dividend Allowance. Dividends in your pension funds or on shares within an ISA will remain tax free and will not impact your dividend allowance. You can find more information and examples in GOV.UK’s Dividend Allowance factsheet.

Many unit trusts can be held in an Individual Savings Account (ISA). In this case, your income and capital gains will be tax-free. Prioritise investing via ISAs and other tax-efficient ways to save or invest.

Any profit you make from selling shares outside an ISA may be subject to Capital Gains Tax.

Irish tax
Ireland has unusual tax rules for investors who live there. For Irish investors, using ITs can lead to real financial benefit.

UCITS fund taxation
Ireland taxes its resident on ETFs and UCITS funds at a rate of 41% of all gains, applied every eight years, either on a deemed sale or on a actual sale. This tax regime is particularly punitive. In addition any losses in other investment assets cannot be offset against ETF or UCITS funds.

Ordinary share taxation
However, Ireland taxes residents holding ordinary shares at the marginal rate of the tax payer, and losses can be offset. Capital gains are subject to normal taxation rate of 33% on any gains on sale.

Taxation of investment trusts
Under Irish tax regulations, investment trusts qualify as shares. This means that they avoid the punitive tax rate on funds. ITs are subject to taxation at the tax payers marginal rate, with the ability to offset losses. For Irish investors, closed end investment trusts are attractive, in particular for investors paying income tax at a higher rate. Any benefit need carefully calculations, particularly around cash flow basis, to assess the exact benefits thinking about marginal tax rates and the duration of the holding period.

As a consequence, Irish investors could consider using ITs for the risk side of their investment portfolio. However, ITs no longer provide a focus on fixed income, so Irish investors still need the usual ETFs and mutual funds for this side of their portfolio. The lower likely income levels from bonds mitigates the higher tax rates that are applicable.

Remittance
Where an investor who is not tax domiciled in Ireland but is resident there, a further anomaly arises: the capital invested by that individual in an IT can grow without taxation. Any income remitted to Ireland from an IT would then be subject to marginal rate income tax only.

Investment factors

 * The price of shares in an investment trust can go up or down, so you could get back less than you invested.
 * The level of risk and return will depend on the investment trust you choose. Find out what type of assets the trust will invest in, as some are riskier than others.
 * Look at the difference between the investment trust’s share price and the value of its assets, as this gap may affect your return. If a discount widens, this can depress returns.
 * Find out if the investment trust borrows money to buy shares. If so, what level of gearing does the investment trust use? Gains might be better; or conversely, your losses could be greater.

Benefits of investment trusts
Investment trusts have some of the characteristics of a Bogleheads portfolio, all contained within one fund structure. The larger global ITs have diversified across the spectrum of stocks and credit assets and other assets. Although generally the cost ratios of ITs are greater than the best iShares or Vanguard ETFs, the larger ITs are becoming more competitive.

There are also global ITs aimed at emerging markets, small cap companies and particular regions, and these could sit beside a global single IT as your main investment vehicle.


 * As a pooled investment fund, you get added scale and diversity in a single vehicle.
 * Gearing can enhance returns, allied however with increased risk.
 * As an investor in an investment trust you can gain access to assets that are generally not available, such as hedge funds, infrastructure and REITs.
 * Investment trusts use active management, and this may or may not lead to improved returns.
 * Purchasing investment trust shares at a discount could provide added value over the longer term.

Access to investment trusts
In the UK you can buy shares from a stockbroker or directly through an Investment Trust Savings and Investment Scheme (ITSS) or from an online share dealing facility, through an IFA and financial planners.

You can also buy shares directly from some investment trust managers.

Investing through a platform means that you can select from a wide range of trusts, switching between them as performance and investment conditions change. And if you regularly use the same platform, you can see all your holdings in one place, allowing you to more easily track relative performance, dividend payments, annual meeting dates and so on at a glance.

Some platforms do not offer investment trusts. This means that you may find that they are difficult to access through an existing platform, and need to use an alternative.

Compare fund platforms provides comparative information on the relative costs of accessing funds in the UK.