Investment trust performance
By Michael Trudeau
Article 2 of 2
Investment trust performance
Learn about the impact of lower costs and gearing - two distinctive characteristics of investment trusts.
Investment trust share holders often invest because they believe trusts will outperform similar 'open-ended' funds such as unit trusts and Oeics (open ended investment companies).
When investment trusts do out-perform their open-ended rivals, as they frequently have in the past, it can usually be explained by a combination of lower costs and the effect of 'gearing'.
Here, we explain the impact of these factors on performance.
Find out more: What is an investment trust? - for more on the differences between open and closed-ended funds
Investment trust costs
Traditionally, investment trusts have had lower ongoing charges than open-ended unit trusts and Oeics. This was always the case because unlike open-ended funds, investment trusts have never paid commission to financial advisers.
And because investment trusts don't have to deal with money coming in and out, there's less administration to pay for. In addition, investment trusts have independent boards of directors representing the interests of the shareholders - as such they will often negotiate lower annual charges as trusts grow.
However, as a result of the Financial Conduct Authority's Retail Distribution Review (RDR), open-ended funds have become cheaper.
Those who buy funds through a financial adviser have been benefiting from so-called 'clean units' with ongoing charges of between 0.75% and 1% since 2013 - the financial advice is now paid for separately, by fee. Those who buy open-ended funds through fund supermarkets have been benefiting from clean units since April 2014. Cheaper open-ended funds could represent a challenge to investment trusts' traditional advantage of fees.
When considering investment trusts, it's also necessary to consider that, like any other shares, but unlike open-ended funds, your deals will be subject to stockbroking commission.
Find out more: Are fund charges eating into your returns? - find out more about the impact of fees on performance
Investment trusts and gearing
Another major difference between investment and unit trusts is that investment trusts can borrow money to invest. This ability (known as gearing) can have a dramatic effect on the value of your investments.
Investment trusts use this borrowed money to invest in shares and other securities. Gearing is very useful when markets are rising as it magnifies any gains you make.
However, when stock markets are falling, gearing will heighten your losses. A trust with a high level of gearing will likely fall further under these circumstances than trusts with low gearing.
This means the more borrowing a trust has, the greater the capital risk you face, but you also have the potential for higher returns. The combined effect of gearing and the discount means investment trusts are likely to be more volatile than equivalent unit trusts.
This means if you invest in investment trusts you should be prepared for a rockier road with bigger ups and downs.
But not all investment trusts gear. The Association of Investment Companies (AIC) publishes details of each trusts gearing policy - a gearing rating of 100 means the trust has no borrowing, a rating of 110 means your gains or losses will be magnified by 10%, etc - in other words, the trust has gearing of 10% of total assets.
- Last updated: February 2016
- Updated by: Michael Trudeau