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Investment Trusts can add a new dimension to a portfolio

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Collective investments such as unit trusts and investment trusts let you access investment opportunities and spread risk across dozens of different companies. Investors’ money is pooled together and run by a manager who buys and sells stocks and shares on their behalf to create a diverse portfolio.

While unit trusts and OEICs are structured as ‘open-ended’ funds, investment trusts are closed ended. With open-ended funds, a fund manager creates units for new investors and cancels them when money is taken out. Therefore the fund grows larger as more people invest, and shrinks as they cash in. An investment trust, meanwhile, has a fixed number of shares which investors can buy and sell on the London Stock Exchange. It is ‘closed ended’ in the sense that when investors buy or sell the shares the Trust’s assets don’t change.

Investment Trusts are sometimes overlooked, but they can have some important advantages. Having a fixed number of shares means there is no need to buy or sell assets to keep up with the demand of investors. This allows a fund manager to be more fully invested as there is no need to keep some cash in reserve to meet redemptions.

It also means that investment trusts can be more appropriate vehicles to access more esoteric, ‘illiquid’ assets that cannot be traded easily, such as commercial property, frontier markets or private companies. Having a fixed pool of assets means that there is no need to engage in lengthy or expensive buying and selling to meet investor demand.

Another important feature of investment trusts is the option to borrow to invest, also known as ‘gearing’. This generally increases the volatility of a trust’s asset value – and share price – which can mean a boost to returns in a rising market. However, the opposite is generally the case in a falling market and, if not carefully managed, a Trust can become burdened with expensive borrowing arrangements.

There are plenty of examples of gearing being successfully implemented. Among the most notable is Scottish Mortgage, which invests in many of the world’s leading technology companies, including Amazon, Tesla and Facebook. It is geared and has appreciated considerably in the last ten years, making use of its structure to invest in both listed and unlisted companies; though past performance is not an indication of future returns.

For income seekers a further defining characteristic of investment trusts is the ability to retain income generated by its underlying assets. This can help smooth dividend payments to investors. For instance, in a recession when lots of dividend cuts take place a Trust can dip into reserves and maintain or even grow its payments. This is appealing to investors who rely on the income their investments generate.

Finally, investment trusts can sometimes offer opportunities to take advantage of depressed investor sentiment. As the share price is determined by supply and demand the market value of the Trust’s assets doesn't necessarily equate to its valuation – it can trade at less than the sum of its parts (a discount) or more (a premium). Savvy investors can potentially take advantage by buying into a pool of assets below their true worth, though there are no guarantees any discount will narrow and investment performance is likely to be a more important factor in overall returns.

This article is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.