Investment trusts can be broadly classified into two. Unit trusts are open-ended, which means that they can issue and buy back units as the need arises. On the other hand, investment trusts are closed-ended, which means that the number of shares issued remains fixed from the time the fund is formed.
There are several other classifications of investment trusts, which vary in terms of risk, asset types, fees, and capital requirements. All these factors can play a crucial part when choosing the trust fund that suits your style. But generally, investment trust funds use the same principle, which allows investors to access a pool of diversified assets from one investment. This can yield several benefits.
Why choose an investment trust fund
There are several reasons why different investors may choose to invest in an investment trust fund. But in general, there are five that stand out.
A consistent flow of income
Investment trusts retain up to 15% of their income in a year. This surplus is used to supplement periods of low returns, thereby enabling the fund to pay a consistent flow of income to shareholders.
This aspect of investment trusts can be very compelling especially to retirement investors that prefer a consistent flow of income rather than periods of unusually high incomes and other periods of low to no income.
A case in point is the way the coronavirus pandemic has affected stocks. Several companies introduced dividend cuts over the last few quarters due to the financial crisis caused by the pandemic. However, investment trusts continued to illustrate why they are a reliable source of regular income.
Just like Ben Lofthouse, the portfolio manager and head of global equity at Janus Henderson Investors writes in a recent blog post, Henderson International Income Trust share price continued to rise since bottoming at the end of Q1, This has boosted the investment trust's capital value from about 100p to 151.50p between March 23 and December 9 this year.
This is a significant rebound following the plunge experienced between February and March. The investment trust's dividend has grown from 1p to 1.50p since 2011.
Get to invest in high-quality companies
Another benefit of investing in investment trusts is that investors gain access to a pool of well-diversified high-quality companies with a single investment. Ordinarily, one would have to spend a lot of money to invest in several companies of the same quality.
The stock price of an investment trust is determined by the forces of demand and supply in the market, which means that investors can buy and sell at a profit for purposes of capital gains— in addition to regular income payments that the fund pays to shareholders.
Take, for instance, the Henderson International Income Trust fund. Just as the name suggests, it is invested in global assets, which means it gives investors access to some of the highest quality companies from around the world. Its global reach also means that it is well diversified.
Investment funds also have access to unlisted companies, which can add unique qualities to the portfolio.
Gearing
Debt is a crucial element of any business and investment trusts are no different. The ability to borrow in order to invest in quality opportunities as they arise enables investment trusts to grow without affecting the value of the funds' shares.
This allows portfolio managers to only issue more shares at the right time rather than being forced by circumstances. On the downside, gearing can also increase the losses incurred by an investment trust during bear markets.
Therefore, the higher the gearing the higher the potential for more returns when the investment trust is performing well. It is always good to relate the fund's historical performances to its gearing ratio to see how returns were affected.
Governance
One of the reasons why investment trusts tend to have few periods of poor returns is because of the legal obligations the trust fund managers are required to observe. The trustees of the fund are required to act with "such care and skills as is reasonable" given the circumstances when managing an investment trust "on behalf of the beneficiaries."
Every investment trust has an independent board of directors that is tasked with safeguarding the interests of the shareholders. The portfolio managers are answerable to the board of directors.
Therefore, this prevents the investment trust managers from investing in assets that do not fit the description of the fund.
Conclusion
In summary, investment trusts are one of the best ways to engage in passive investing. They provide a consistent flow of income while at the same time allowing shareholders to sell their stock to the public market for potential capital gains.
