What are investment companies?
Introducing an investment fund with a unique collection of features.
What are investment companies (investment trusts)?
A guide to getting started
Investment companies exist solely to invest. They allow you to make a single investment which gives you a share in a much larger portfolio.
Investment companies are a type of collective investment which allows you to spread your risk and access investment opportunities that you wouldn’t be able to invest in on your own.
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.
Investment companies have strong long-term performance.
Listed on a stock exchange
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 if you’re a UK investor, you’ll find most of them 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 ready to give investors their money back at any time. So they normally invest only in assets which can be sold very quickly.
Because investment companies are closed-ended, they don’t have to deal with these inflows and outflows of money. This allows them to invest in assets which can be hard to buy and sell like infrastructure, private companies or 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 into 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’.
Discounts and premiums
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, divided by the number of shares.
The NAV of a share is the value of all the investment company’s assets, less liabilities such as any debt, divided by the number of shares. However, because investment company shares are bought and sold on the 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.
|Discount / Premium
More often than not, investment company shares tend to trade at a discount.
When an investment company trades at a discount, it can be a good opportunity to buy. 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.
When the discount changes
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 price rises more than the NAV, narrowing the discount, you’ll get a better return than the 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 NAV but you won’t necessarily make a loss.
- If the discount widens as the share price and the NAV are both falling, you will lose more than the fall in the NAV.
Boards of directors
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 (including interest) 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.
While all gearing adds risk, being able to gear is an advantage investment companies have over other kinds of fund, such as unit trusts, which are not permitted to do it.
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 several investment companies. The board of directors select the fund manager (or managers).
With interest rates at very low levels, many investors want 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.
To find out more, read our guide ‘Looking for a little bit more’.
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.
Specialisation in particular sectors
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 invest 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.
- Different kinds of assets, such as property or infrastructure.
Something a bit different
Whether you are looking to diversify your existing portfolio, boost your income or maximise long-term capital growth, investment companies can provide the best way to access alternative asset classes as part of a long-term balanced portfolio. This guide looks at some of the main types of alternative assets, and explains the key benefits and risks.
Whatever your investment style or goal, investment companies can offer a solution to match.
Different types of investment companies
Different types of investment company
An investment company is a company listed on a stock exchange which invests in shares and other assets, but there are a few different types of investment company to be aware of:
- Investment trusts.
- Non-UK investment companies.
- Real Estate Investment Trusts (REITs).
- Venture capital trusts (VCTs).
Investment trusts are the most common type of investment company. Investment trusts are investment companies which are based in the UK and which meet certain conditions such as paying out a certain amount of the income they receive from their investments.
Often, the term investment trust is used to refer to any kind of investment company.
Non-UK investment companies
Non-UK investment companies are very similar to investment trusts, but they are based in areas other than the UK. Many non-UK investment companies are based in the Channel Islands, for example. Because they aren’t based in the UK, investors don’t have to pay stamp duty when they buy non-UK investment company shares.
Real Estate Investment Trusts (REITs)
Many investment companies that invest in property are structured as Real Estate Investment Trusts (REITs). REITs have similar, but different rules to investment trusts. They are companies that:
- Own commercial or residential property and rent it out.
- Have to distribute 90% of the profits they make from their rental business to the REIT’s shareholders.
- Do not have to pay corporation tax on profits from the rental business.
Shareholders in REITs pay income tax, as opposed to dividend tax, on the distributions that are made to them in this way. The general idea is that they are taxed as though they owned the properties themselves. Of course, if REIT shares are held in an account such as an ISA or a SIPP, no tax is paid on the distributions, making REITs a tax-efficient way to invest in property.
Venture capital trusts (VCTs)
Venture capital trusts (VCTs) invest in some of the most dynamic small businesses in the UK to help them grow. Because of the economic growth these businesses can create, the government offers generous tax benefits when you invest in VCTs. To find out more about VCTs, read the visit the VCT section of this guide.
Different types of shares and securities
There are different types of investment company shares which investors can buy. Most are ‘ordinary’ shares but there a couple of other options. However, different types of shares are specialist investments and investors who are just starting out should make sure they are comfortable with ordinary shares first.
This type of financial instrument has a limited life and can be converted into new ordinary shares in the company at some time in the future at a fixed price known as the strike price.
Warrants have similar characteristics to subscription shares. They don’t have the same rights as ordinary shares (e.g. they are not entitled to any dividends before they are converted into the ordinary shares). They are also much higher risk than ordinary shares, because if the share price of the ordinary shares is lower than the warrants’ strike price, the warrants will have limited value. So it’s possible for warrants to expire worthless and you could lose all the money you paid for them.
Convertibles are shares or securities which can be converted into ordinary shares at some time in the future.
Why choose investment companies?
Every investment offers benefits and risks. The benefits include the opportunity to grow the value of your money, to generate an income or to diversify your savings. The risks are that you could lose your money or that you might get back less than you invested.
You should not invest if you cannot afford to lose your money, if you need a guaranteed income or if you’re not prepared to see the value of your investments fall. If you are unsure, it’s important to get independent financial advice.
If you feel that investing with funds could be for you, investment companies have important benefits and risks over open-ended funds which are important to know.
Benefits of investment companies compared to other types of fund
- Closed-ended structure – this allows the manager to make longer-term decisions, without having to worry about needing to sell assets when investors sell their shares in the investment company.
- Listed on a stock exchange – this offers you the ability to buy and sell shares at any time in normal trading hours.
- Boards of directors – they provide an additional layer of oversight, protecting your interests.
- Gearing – the ability of investment companies to borrow money to invest means that they may perform better over the long term (but see risks below).
- Ability to invest in hard-to-sell assets – like private equity, infrastructure, and social and environmental impact investments.
- Consistent income – investment companies can smooth the income they pay out from year to year by reserving income in good years to pay out later. Watch the video below to find out more.
Risks of investment companies compared to other types of fund
- Gearing – if an investment company uses gearing, this will make your returns worse in periods when markets go down.
- Discounts – if an investment company discount widens when markets go down, you are likely to suffer a bigger loss than if you had invested in a similar open-ended fund.
Who might investment companies be suitable for?
First of all, investment companies won’t be suitable for you if you can’t accept the usual risks that come with investing, such as losing money, or seeing income from your investments fall.
If you can accept the risks that come with investing, the question still remains: are investment companies the right investments for you?
You need to think about this carefully, and if in doubt, consult a financial adviser. The following is only a general guide and can’t take into account your individual circumstances.
Investment companies could be suitable for you if you want:
- Strong growth in your investments over the long term.
- An income which rises consistently over time, or a higher level of income.
- An independent board protecting your interests.
- Access to alternative assets like infrastructure or property.
- The ability to buy and sell shares at any time during the trading day.
On the other hand, investment companies will not be suitable for you if you:
- Have an investment time horizon of less than five years.
- Need a guaranteed return.
- Need a guaranteed income.
- Can’t accept the risks that come with gearing and discounts.
- Want an investment where the price always matches the value of the underlying assets.