Article from http://www.everyinvestor.co.uk
Here are 10 facts for investors to bear in mind when researching funds
1) Closed-ended rather than open-ended
Investment trusts are ‘closed-ended’ investments, usually with a fixed number of shares in issue. This effectively means investment trust managers have a fixed pool of money to invest, unlike unit trusts that create or cancel units depending on demand, depending upon whether money is flowing into or out of the fund.
2) Premiums/discounts
A consequence of being ‘closed-ended’ is that the price of an investment trust is driven by supply and demand. If a trust is popular with investors, its price can be driven higher than its net asset value (NAV) – the value of the underlying investments. This is known as trading at a premium. Conversely if supply exceeds demand the price can be driven lower than the NAV – known as trading at a discount. This is in contrast to unit trusts and open-ended investment companies (OEICs), whose price is solely dictated by the NAV.
3) Pricing
Shares in investment trusts are traded on the London Stock Exchange and the price will vary throughout the trading day. Unit trusts/OEICs are valued once a day, in most cases at 12.00 noon.
4) Exposure to areas not covered by unit trusts
The closed-ended structure makes it easier for investment trusts to focus on less well-known and niche areas, where investments can be harder to buy and sell in large quantities. Examples include trusts that invest in private equity, property, or more obscure stock markets such as those in developing countries.
5) Gearing
Investment trust managers have the flexibility to borrow money in order to purchase investments – this is referred to as ‘gearing’. If the total assets of a trust are worth £100 million, and the manager borrows £10 million, this is expressed as 110% gearing. This can enhance returns if the manager makes the right decisions, but magnify losses if the opposite were true. The increased risk plus the cost of borrowing the money need to be factored in.
6) Performance
In a rising market, as we have seen over the past five years, gearing can help generate superior returns for investment trusts compared to unit trusts as the manager has more capital invested in the stock market. However, during 2008′s crisis, heavily geared investment trusts suffered significantly higher losses than comparable unit trusts, which do not use gearing.
7) Smoothed dividends
Investment trust managers can hold back up to 15% of the income generated by the underlying investments each year. This creates a cash reserve that can be used to boost dividends in tougher times. Trusts that use this facility therefore often have more consistent dividend records – in some cases delivering many consecutive years of dividend growth for their investors.
8) Choice
There are approximately 400 investment trusts compared to around 2,500 unit trusts/OEICS.
9) Charges
Investment trusts and unit trusts carry similar charging structures, but investment trusts are more likely to have performance fees.
10) Information
Knowing a fund or trust’s underlying holdings is a key factor when analysing and deciding whether to invest. This information is usually widely available from unit trusts and some larger investment trusts. However, it is not always readily available from smaller trusts.
Danny Cox on Wednesday, 7 May 2014 at 15:16
Article from http://www.everyinvestor.co.uk
