What are investment companies (investment trusts)?
Investment companies (often known as investment trusts) are a type of fund. They have a number of unique features which we will explore in this section.
- Listed on a stock exchange
- Closed-ended structure
- Share prices
- Discounts and premiums
- When the discount changes
- Boards of directors
- Shareholder democracy
- Specialisation in particular sectors
One of the unique features of investment companies is that they are public limited companies (plcs). Their shares are listed on a stock exchange just like those of any other public company and you invest in investment companies by buying and selling their shares.
Investment companies can be listed on one of several stock exchanges but the majority are listed on the London Stock Exchange.
Investment companies are known as closed-ended, as opposed to unit trusts which are open-ended.
What’s meant by investment companies being closed-ended is that they have a fixed number of shares in issue at any one time. You invest in an investment company by buying the shares from another investor on the stock market. Similarly, when you want to sell your shares, you sell them to another investor.
In contrast, open-ended funds expand or contract depending on demand as investors move their money in and out of the fund. This means open-ended funds have to be managed in way so that they can give investors their money back at any time. This includes normally investing only in assets which can be sold very quickly and keeping part of the fund in cash to cover withdrawals.
Because investment companies are closed-ended, they don’t have to deal with these inflows and outflows. This allows them to invest in assets which can be hard to buy and sell like infrastructure, private companies or specialist property, with the potential to deliver better long-term returns or higher levels of income. It also enables investment company managers to make long-term investment decisions as they don’t have to buy and sell investments based on investors moving money in or out of the fund.
When you invest in an investment company you buy its shares on the stock market. There a few different ways that share prices can be shown.
The price you buy shares for is higher than the price you sell shares for. The buying price is called the ‘offer’ price. The selling price is called the ‘bid’ price.
The difference between these two prices is called the ‘bid-offer spread’.
There are two ways that the value of a share in an investment company is often expressed:
- The share price – the price you actually buy and sell at.
- The net asset value per share (NAV) – the value of the investment company’s assets, less any liabilities it has, divided by the number of shares.
The NAV of a share is the value of all the investment company’s assets, less any liabilities such as any debt, divided by the number of shares. However, because investment company shares are bought and sold on a stock market, the share price is affected by supply and demand, so it might be higher or lower than the NAV. The difference is known as a discount or premium.
- Buying shares at a discount means you pay less than the NAV.
- Buying at a premium means you pay more than the NAV.
More often than not, investment company shares tend to trade at a discount.
An investment company trading at a discount can be a buying opportunity. However, you shouldn’t assume that buying at a discount is automatically a good thing. The price of investment company shares depends on a whole range of things, including the sentiment towards the investment company, its investment strategy and the type of investments it holds. There may be a good reason why it is trading at a discount.
If you invest in an investment company it should be for the long term, so changes in the discount shouldn’t make too much difference – but it’s worth understanding nevertheless.
- If you buy at a discount and the share prices rises faster than the NAV, narrowing the discount, you’ll get a better return than the underlying NAV.
- If the discount widens, for example by the NAV rising faster than the share price, you won’t get as good a return as the underlying NAV but you won’t necessarily make a loss.
Because investment companies are public limited companies (plcs), they have independent boards of directors, just like any other plc. The directors’ duty is to look after your interests as an investor, by ensuring the company is as successful as possible.
The directors meet several times a year and monitor the company’s performance. They answer to the shareholders, which means you have some say in how the company is run.
When you buy a share in an investment company you become a shareholder. Shareholders in investment companies have the same rights as other shareholders in other companies.
- Vote on issues at the company's annual general meeting (AGM).
- Table motions to be discussed.
- Call for extraordinary general meetings (EGMs).
- Vote in new directors if they are not happy with the current ones.
In other collective investments, you don’t have as much of a say in how the fund is run.
Investment companies, being companies, can borrow money to make additional investments. This is called gearing. It lets the company take advantage of a long-term plan or a particularly attractive stock without having to sell existing investments.
The idea is that the additional investment makes enough money to pay off the loan and make a profit on top of that. If it works, the more the company borrows, the more profit it makes. If the investment fails, the more the company borrows, the more it loses. So the more an investment company borrows the more risky it is.
Investment companies can usually borrow at lower rates of interest than you’d get as an individual. They also have flexible ways to borrow – for example they might get an ordinary bank loan, or issue preference shares.
Not all investment companies use gearing. Many of those that do use modest levels. It’s a decision taken by the fund manager and the board of directors. The gearing policy of the company may change from time to time. It’s regularly reviewed by the board and manager.
Other kinds of collective investments can’t use gearing to the same extent as investment companies.
Each company has a fund manager who makes the day to day decisions about what stocks and other investments to buy and sell.
Most investment companies are managed by an external management group which may manage a number of companies. The board of directors select the fund manager (or managers).
With interest rates at very low levels, many investors are wanting to generate income from their investments.
Investment companies have a number of advantages when it comes to delivering high levels of income, or income that grows over time.
If you know which income-paying investment companies you are interested in, visit Income Finder, our set of tools and resources for income-seeking investors. Income Finder allows you to create a virtual portfolio of income-paying investment companies, track the dividend dates and see how much income you could receive over a year.
Investment companies can invest in a much wider range of investments than other types of fund. In fact, they can invest in almost anything. The investment company will set out its particular approach in its investment policy.
Investment companies can specialise in:
- Mainstream global companies.
- Companies from specific parts of the world.
- A particular type of company, like smaller companies.
- Particular business sectors, like technology or commodities.