How to research investment trusts for your Isa

Ryan Hughes is head of active portfolios at financial services firm AJ Bell.

Investment trusts represent an excellent way to invest whether you are just starting out or have already established a well-diversified portfolio.

However, they do have some interesting quirks and features that mean careful research is important in order to fully understand what you are buying.

Market watch: Investment trusts are traded on the stock market and they can borrow money to try to enhance returns

1. How does the trust invest?

First and foremost, the oddity about investment trusts is that many of them have a name that doesn’t tell you much about what they do.

Scottish Mortgage doesn’t invest in mortgages, Monks isn’t linked to the church and Temple Bar isn’t based in the famous drinking area of Dublin.

Therefore, it’s vital to look beyond the name of the trust and take a close look at what it actually does to see if it fits with your objectives.

It could be growth or income, high risk or low risk; there is a lot of choice and understanding the approach is key.

2. Who is the manager?

That leads on to the next element which is taking a close look at the fund manager running the trust.

Ryan Hughes: Investment trusts typically cost less to own than open ended funds

Ryan Hughes: Investment trusts typically cost less to own than open ended funds

Trusts operate with independent boards just like a company and these boards have the power to hire and fire the fund managers.

Therefore, when looking at past performance, it’s important to ensure that the track record relates to the current managers as in recent times quite a lot of investment trusts have changed who runs them.

When looking at the manager, the research should focus on how they invest as this helps understand whether the trust may be suitable for your objectives.

This means looking at where they invest geographically, the type of investment they buy, the types of companies they buy and how much risk they typically take.

3. What do company accounts reveal?

As investment trusts are companies, they have to produce a set of reports and accounts twice a year.

In this document is some explanation from both the board and the fund managers about what the trust does and how it goes about it.

These documents are a great starting point for investors wanting to research an investment opportunity even if all the numbers in the accounts may not make sense.

4. Does the trust trade at a discount or premium?

Investment trusts have some different characteristics to open-ended funds and one of the key differences is that they can trade on a discount or premium.

An investment trust is traded on the stock market and therefore sometimes its price doesn’t reflect the value of the underlying investments.

How do funds and trusts work? 

Read This is Money’s guide to open-ended investment funds here, and our guide to investment trusts here. 

If the price is below the value of the assets, then it is trading at a discount, while if it is above, it is trading at a premium.

Given this situation, it is worth looking at the trust to understand how it has previously and is currently trading. Trading at a big discount might look like you are getting a bargain but there could be a good reason why its price doesn’t reflect the assets.

Equally, if a trust is trading at a premium, you need to be very sure that you are prepared to pay more than something is worth.

Both situations are common, and neither can be bad but understanding why a trust might trade like this is important.

The boards of investment trusts often have a stated policy around the discount or premium and therefore finding this out will help spot what the likely discount or premium could be in the future.

5. Does it have debt?

Another characteristic of investment trusts is their ability to borrow money to try to enhance returns which is known as gearing.

Many investment trusts use this approach but it’s important to remember that just as it can enhance good returns, it can exacerbate bad returns.

Therefore, checking the current level of gearing on a trust and how the manager has used it historically is a sensible approach as it gives an idea of the level of risk being taken.

6. How much does it cost?

One of the advantages of investment trusts is that typically they cost less to own than open ended funds. 

The ongoing charge figure shows how much an investor paid over the past 12 months and the average UK equity investment trust has an OCF of 0.70 per cent compared to 0.90 per cent for the average actively managed open ended UK equity fund. 

This might not sound much different but over the long term this can have an enormous impact on your investment. 

This lower cost is partly due to the independent board who negotiate fees with the fund managers and also lower running costs due to the different structure that keeps things like sales and marketing costs down. 

However, it’s worth noting that as investment trusts trade on the stock market, there are higher dealing costs to consider. 

7. How much does the trust yield?

One attractive feature of an investment trust is it doesn’t need to pay out all of its income each year as a dividend. 

This means in the good years it can hold some income back to use in the tougher years to keep dividends appealing. 

This is exactly what happened in 2020 when many companies cut their dividends but investment trusts were able to use their reserves to maintain or grow the income. 

It’s therefore worth looking at the dividend cover figure as this shows how much of the current yield can be paid from reserves. 

What do cryptic fund and trust names mean? 

 Alpha, focus, dynamic, optimal… read This is Money’s jargon busting guide here. 

The higher the figure, the better the chance of the trust maintaining or growing income when times are tough.

8. Where can you find information on trusts?

Investment trusts are great investment vehicles that offer investors a wide variety of choice of different approaches.

The Association of Investment Companies which represents investment trusts has a great website that contains loads of useful information about them.

This includes educational material that explains in more detail some of the areas covered here as well as lots of specific statistics to help understand what particular investment trusts are doing.

9. Review the performance of your investment trusts

It’s important to remember that if you are choosing investments, the work doesn’t stop once you have invested.

Ongoing monitoring is just as important as initial research as trusts can and do change so keep an eye on your portfolio to make sure that your investments remain suitable to meet your objectives and risk level.

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