The Financial Times once described Investment Trusts as ‘the City’s best-kept secret’. Many private investors, charities and smaller pension funds remain unaware of them. The amount of money invested in ‘closed end’ Investment Trusts has risen by only 50%, to £100 billion over the last 10 years. However, the amount of money invested in ‘open-ended’ companies has reportedly risen three-fold to over £600 billion over the same period. So are investors missing a trick in recognising some of the advantages of investing in closed-end Investment Trusts? Let’s take a closer look.
Open vs. Closed Funds
Before exploring the advantages of closed-end Investment Trusts, it is important to understand the difference been ‘open-ended’ and ‘closed-ended’ funds. In the UK, most investment companies are 'open-ended'. When investors buy (or sell) ‘open-end’ funds, they add to (or subtract from) the assets under management. ‘Open-ended’ funds issue (or cancel) shares as investors deposit (or withdraw) money. By contrast, Investment Trusts are 'closed-end'. When investors buy (or sell) shares in ‘closed-end’ companies, they own a small part of the Investment Trust. However, the number of shares remains the same, and the value of assets under management does not change.
Strong Dividend Records
Many Investment Trusts have been able to increase their dividend year after year, over a long period of time. Indeed, research by the AIC (Association of Investment Companies) suggests ‘that a fifth (21%) of AIC member investment companies which have been in existence for more than 10 years have raised their dividends for at least 10 years in a row.’
This is partially because Trusts are able to retain income in good years in order to pay dividends when the going gets tough. This is known as 'smoothing dividends'. Open-ended funds are required to pay out dividends which are roughly equivalent to the income they receive from stocks (and other securities) they have invested in. On the other hand, Investment Trusts can build up ‘revenue reserves’, as they only have to pay out 85% of income each year. The remaining 15% can be used to make future payments.
Gearing
Another important difference between Investment Trusts and unit trusts is that Investment Trusts can borrow money to invest in shares and other securities. This is known as gearing. It enables Investment Trusts to take greater advantage of investment opportunities. If managers identify an underpriced stock, they can borrow money, rather than sell stocks in order to…
