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Overlooked option for the long haul
By Hannah Ricci
If you want to build up a fund over 10 years or more, investment trusts are a great home for your money. It's as simple as that. You may be surprised, perhaps because you haven't heard of investment trusts, or because their better-known relations - unit trusts and open-ended investment companies - are often touted as more attractive propositions.
But ignore investment trusts and you could be turning your back on fabulous returns. According to the Association of Investment Companies (AIC), at the end of January 2008, £1,000 invested 10 years ago in the average investment trust would have grown to £2,292, and to £3,994 if invested 15 years ago.What are they?Investment trusts are also called investment companies because that's just what they are: companies listed on the stock exchange in the same way as companies such as Tesco or Vodafone. But unlike companies that sell products or services, investment trusts make money from buying and selling shares in other companies - Tesco or Vodafone, for example.
With more than 300 investment trusts to choose from - excluding venture capital trusts - there is generally something for every type of investor. You can pick a fund to match your attitude to risk, the type of market you would like to invest in, and whereabouts in the world you want exposure to.
You can also choose an investment trust depending on the type of return you want. Some aim to maximise income for shareholders; others invest for capital growth over the long term, while some provide a combination of income and growth.
Investment trusts are similar to OEICs and unit trusts in that they are a form of collective investment. This means the money of many investors is pooled to provide the benefits of economies of scale, bringing down dealing and administration costs. This also reduces risk; trusts hold shares in a range of companies so buying into just one fund effectively gives you ready-made diversification.
This is where the similarity with unit trusts and OEICs ends, because the structure and management of investment trusts is very different.
"It's fair to say that investment trusts are less recommended by independent financial advisers than other collective investments because their make-up is more complex, which makes them riskier," says Chris Shaw, an IFA at Beacon Asset Management. "But it's also because, unlike unit trusts and OEICs, they do not pay commission, which deters some advisers."How do they work?An investment trust issues a set number of shares, which makes it closed-ended because the number of shares does not fluctuate according to demand in the same way as unit trusts and OEICs, which are open-ended.
This means the price of investment trusts goes up and down in relation to supply and demand. If a lot of people want to buy into a particular fund, shares trade at a premium, basically at a higher value than the underlying assets. Equally, if there aren't enough buyers, the shares sell at a discount.
Investment trusts are also priced differently. If you add up all the available shareholder contributions in a fund - its assets minus its liabilities - and divide that by the number of shares in the fund, you have the net asset value. "Yet because investment trusts are listed on the stock exchange, the share price is determined by supply and demand, so it may not match the NAV per share, which can be confusing to investors," explains Shaw.
Investment trusts are also allowed to borrow money, or 'gear', meaning fund managers can take advantage of good opportunities and borrow to buy more shares. The idea is to make a high enough return on the investments to repay the costs of the loan and still make a profit.
The higher the level of gearing the higher the risk, so while it helps when markets are performing well, the reverse is true if markets take a dip when a fund is heavily geared. "Managers need to judge the market well because gearing can make the growth or loss snowball, so you really don't want to be geared when markets fall," adds Shaw.
This feature makes investment trusts more suitable for long-term investors who can afford the time to ride out any fluctuations. If you don't have any emergency cash savings, or anticipate needing access to funds in the short-term, an investment trust probably isn't the best home for your money and you should consider cash-based investments instead.Costs and chargesInvestment trusts have much lower charges than unit trusts and OEICs because they have boards of directors, separate to the fund manager, which govern the company to secure the best possible returns for shareholders and keep running costs to a minimum.
Another reason, as Shaw points out, is that investment trusts don't pay commission to IFAs, or splash out on extensive marketing.Investment trusts don't have an initial charge, although normal stamp duty of 0.5% applies when buying shares, and there is an annual management charge, usually between 0.5% and 1%. Unit trusts, by comparison, charge management fees of about 1% and initial charges between 3% and 5%.Share classesSome investment trusts offer different types of shares, which is where they can become complicated. Those issuing just one class of ordinary share are known as 'conventional' investment companies.
Investment trusts that issue different classes of shares offering different rights and levels of risk to investors are known as split capital investment trusts, or 'split caps'.
According to the AIC, some split caps aim to pay regular dividends for investors who want an income, while others aim to pay out only a capital amount at the end of the company's life. This offers extra flexibility, but also adds another layer of risk. Who are they suitable for?With such a variety of investment trusts to choose from, there is generally something for everyone who wants to invest for the long term. "As they are naturally more volatile than unit trusts, investment trusts are usually taken up by the more risk-tolerant, but they are a good vehicle for all types of investors," says Shaw. "They can be especially good for saving for children."
But because they are more complex than other collective investments, it's crucial to do your research. The AIC website (theaic.co.uk) is a good source of background information, but if this is a new area to you, it's worth seeking the professional advice of a stockbroker or independent financial adviser. They will charge a fee.
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