Best performing investment trusts for your ISA

Investment trusts have been around for more than 150 years — and their unique qualities make them attractive to a variety of investors. Investment trusts are very similar to ‘funds’, in that investors’ cash is pooled and can be put to work across a wide range of areas, including other companies and alternative asset classes.

Five unique characteristics of investment trusts

Investment trusts are also companies in their own right that are listed and traded on the London Stock Market in the same way as you would hold shares in corporate giants such as BP or Shell. But they also have five extra characteristics. These are:

• • Revenue reserves
  • Closed-ended structure
  • Premiums and discounts
  • Gearing
  • Independent board

What are revenue reserves?

Investment trusts can set aside up to 20% of their generated income during prosperous years. This stash, known as revenue reserves, acts as a safety net. When times are tough (think of the global pandemic as a recent example), they can dip into this reserve to maintain consistent dividend payouts to investors. Think of it as having a financial cushion to weather the ups and downs. A recent example of this would be during the global pandemic when global dividends fell.

What does a closed-ended structure mean?

Imagine a club with a fixed number of memberships. Investment trusts work in a similar way. They are ‘closed-ended,’ meaning there’s a limited number of shares available. This unique structure allows them to delve into specialised and less liquid market areas alongside more traditional equity or bond holdings that other investment options might find challenging.

Premiums and discounts explained

The value of an investment trust doesn’t always mirror the net asset value (NAV) of its underlying holdings. Sometimes, it can trade at a premium or a discount. If the trust is popular, its value may go above the NAV (premium). On the flip side, if it’s less popular, it might trade below the NAV (discount). Understanding this dynamic adds a layer of flexibility to your investment strategy.

What is gearing?

It’s like borrowing money to potentially boost returns. When trust managers are confident about an asset’s growth, they can borrow funds to invest more. This strategy can magnify gains, but it’s a double-edged sword. If things go south, losses can also be amplified. Gearing is a powerful tool that requires careful consideration.

Independent board

To ensure your interests are prioritised, investment trusts operate with an independent board. This board acts as a guardian, meeting regularly to keep a close eye on the trust’s performance. Their duty is to represent shareholders. It’s like having a team of experts working to safeguard your investment. For example, they may choose to change the manger if they feel that is in the best interest of shareholders for the long-term.

Best performing Elite Rated investment trusts over 5 years*

Why investment trusts today?

In October 2023, we reported a “once-in-a-generation chance to buy investment trusts” when the average discount widened to nearly 16%**. Discounts can present an attractive buying opportunity and investors willing to buy at wide discounts could ultimately be rewarded with a double whammy of valuations rising and discounts narrowing.

Of course, a trust could be trading on a discount for numerous reasons. For example, sentiment may just be weak on a trust – meaning investors think the asset value will go down. If an area is very unfashionable – as Japan has been for much of the past decade, or the UK is today – owners of shares wanting to sell will need to be prepared to offer their shares at a discounted price to attract potential buyers. However, poor sentiment is sometimes unwarranted, creating major opportunities for investors.

Ultimately, it’s always important to do your research. As of 30 January 2024, all rated investment trusts, with the exception of The City of London Investment Trust, are trading at a discount. Here is a list of our Elite Rated investment trusts trading on double digit discounts.

Uzo Ekwue, co-manager of the Schroder British Opportunities Trust, gave an update on the investment strategy and the nearly 30% discount to the market on the ‘Investing in the go’ podcast. 

To conclude

Understanding the unique features of investment trusts can empower you to make informed decisions. With revenue reserves, a closed-ended structure, considerations of premiums and discounts, the potential of gearing, and the watchful eye of an independent board, investment trusts offer a unique toolkit for investors seeking a diversified and dynamic approach to wealth building.

Consider adding stable and globally diversified investment trusts to your portfolio, especially those in the global sector. They can serve as a solid foundation for your investments. Moreover, some global and UK investment trusts are great for those looking for regular income. These trusts are skilled at maintaining consistent dividend payments over time, making them a suitable choice for income-focused investors.

*Source: FE Analytics, total returns in sterling, 26 January 2019 to 26 January 2024

**Source: AIC, 24 October 2023

***Source: AIC, data at 30 January 2024