Investment Trusts Explained

Investment trusts are the grandparents of the fund world, the first, Foreign & Colonial, launched in 1868 and still trades today. Yet many UK investors overlook them in favour of newer open-ended funds. That is a shame, because their unusual structure gives them powers that ordinary funds simply do not have: the ability to borrow, to hold hard-to-sell assets, and to store away income for a rainy day.

This guide explains what an investment trust actually is, how it differs from a unit trust or OEIC, and the handful of features, gearing, discounts and dividend reserves, that every investor should understand before buying one. If you are still finding your feet, our beginner’s guide to investing is a gentler starting point.

What an investment trust is

An investment trust is a public limited company listed on the London Stock Exchange whose sole business is to invest in a portfolio of other assets, usually shares, but sometimes bonds, property, infrastructure or private companies. When you buy an investment trust you are buying shares in that company, exactly as you would buy shares in a supermarket or a bank. The company then pools everyone’s money and a professional manager invests it according to a stated objective.

The defining feature is that a trust is closed-ended: it issues a fixed number of shares at launch and does not routinely create or cancel them. If you want to invest, you buy existing shares from another investor through the market; you are not handing new money to the fund. That single fact drives almost everything that makes trusts distinctive.

Trusts vs open-ended funds

The alternative, a unit trust or OEIC (open-ended investment company), is open-ended. It grows and shrinks as investors pour money in or pull it out, creating and cancelling units so the price always equals the net asset value (NAV) per unit. Both structures give you diversified, professionally managed exposure, but they behave differently under the bonnet.

That fixed pool of capital is a genuine advantage in a downturn. An open-ended property fund hit by a wave of redemptions may have to dump buildings at fire-sale prices or freeze withdrawals altogether, as several UK funds did in 2016 and 2020. A closed-ended trust holding the same buildings never faces that problem, because unhappy investors sell their shares to someone else rather than back to the fund.

The trade-off is liquidity of a different kind. Because a trust’s shares are bought and sold on the market, in a panic you may only be able to sell at a wide discount, crystallising a loss on top of any fall in the underlying assets. Open-ended funds spare you that, since you always transact at NAV. Neither structure is universally better; they simply move the risk around. For long-term investors who can sit out the wobbles, the closed-ended format’s freedom from forced selling is usually the more valuable feature, which is one reason trusts have historically been strong performers over long periods.

Discounts and premiums

Because a trust’s shares trade freely, their price is set by supply and demand, and that price can drift away from the value of the underlying portfolio. If the shares cost less than the NAV per share, the trust trades at a discount; if they cost more, it trades at a premium. A trust with £100m of assets and 100m shares has a NAV of £1; if the shares change hands at 90p, that is a 10% discount.

Discounts are the closest thing investing offers to a bargain bin, but they need care. Buying at a wide discount that later narrows gives you a return on top of the portfolio’s performance; but a discount can also widen further, and some trusts sit on persistent discounts for good reasons, poor performance, an out-of-favour sector, or high borrowing. Reading the discount alongside the trust’s track record matters more than chasing the number alone.

Gearing: the double-edged sword

Gearing is the trust’s ability to borrow money to invest alongside shareholders’ capital. A trust with £100m of assets that borrows £10m is 10% geared. When markets rise, that extra £10m is working for you and magnifies the gain; when markets fall, the losses are magnified too, because the debt still has to be repaid regardless of what the portfolio has done. Gearing is why a trust can outperform its open-ended cousins in good years and lag badly in poor ones.

There is nothing sinister about modest gearing in the hands of a disciplined board: it is one of the structural advantages of the closed-ended format. But it does raise the risk, and it is a key reason investment trusts belong in the growth part of a diversified portfolio rather than the money you cannot afford to lose. Understanding how much risk you are comfortable taking is worth doing before you buy; the principles run right across the investing hub.

Income and dividend reserves

For income investors, the trust structure has a killer feature. In good years a trust can hold back up to 15% of the income it receives in a revenue reserve, then draw on that store in lean years to keep paying, and even growing, its dividend. Open-ended funds cannot do this; they must pay out what they earn. It is why a small band of trusts, nicknamed the “dividend heroes”, have raised their payout every single year for half a century or more, straight through recessions and market crashes.

That smoothing makes trusts a natural building block for anyone drawing an income from their investments, a topic we explore in our guide on building an investment portfolio. Remember, though, that dividends are never guaranteed and a reserve can run dry; a high headline yield is sometimes a warning sign, not a gift.

Trusts can also pay income out of capital where their rules permit, which some use to offer a steady, predictable dividend even when the underlying holdings yield little, handy for a growth portfolio you also want to draw on. It is a genuinely useful feature, but read the small print: paying income from capital means less is left to grow, so an eye-catching yield funded this way can slowly shrink the pot behind it. As ever, understanding where the money is really coming from matters more than the headline percentage.

Costs and charges

Trusts publish an ongoing charges figure (OCF) covering the management and running costs. They are often competitive with active open-ended funds, though specialist trusts holding property or private equity can be dearer. On top of the OCF you pay the normal costs of buying a share, a dealing commission and, on purchases, 0.5% stamp duty. The table below shows the main charges to weigh up.

Because platform charges vary so much, a low-cost trust on an expensive platform can end up dearer than the reverse. If you are weighing up who does the work, the same fee logic in our guide on what financial advice costs applies to the platforms and products underneath the advice too.

How to buy an investment trust

• 1

  Open the right account

  A stocks and shares ISA shelters gains and income from tax; a SIPP does the same inside a pension. A general investment account works once those allowances are used.

• 2

  Check the objective and holdings

  Read the trust’s factsheet: what it invests in, how concentrated it is, and whether that fits the rest of your portfolio.

• 3

  Look at the discount and gearing

  A wide discount can be an opportunity or a warning; higher gearing means higher risk. Neither is good or bad in isolation.

• 4

  Weigh the total cost

  Add the OCF, dealing charges and your platform fee together: the headline charge alone can mislead.

• 5

  Diversify

  One trust is rarely a portfolio. Spread across regions, sectors and asset types to avoid putting too much on a single manager.

Investment trusts reward investors who take the time to understand their mechanics, but the closed-ended structure adds moving parts that not everyone wants to monitor. If you would value a professional building and running a diversified portfolio around your goals, Vetted Wealth can match you, free, with an independently vetted, FCA-regulated adviser through our investment management service. Every adviser on our panel is checked for their qualifications, permissions and track record, so you can focus on the plan rather than the vetting.