Investment trusts, unlike unit trusts, can borrow money to buy shares (known as ‘gearing’). This extra buying potential can produce gains in rising markets but also accentuate losses in falling markets. Investment trusts generally have more freedom to borrow than unit trusts that can be sold to the general public.
Unlike with a unit trust, if an investor wants to sell their shares in an investment trust, they must find someone else to buy their shares – this is usually done by selling on the stock market. The investment trust manager is not obliged to buy back shares before the trust’s winding up date.
The price of shares in an investment trust can be lower or higher than the value of the assets attributable to each share – this is known as ‘trading at a discount’ or ‘at a premium’.
Split Capital Investment Trusts
These run for a specified time, usually five to ten years, although you are not tied in. This type of investment trust issues different types of shares. When they reach the end of their term, payouts are made in order of share type.
You can choose a share type to suit you. Typically, the further along the order of payment the share is, the greater the risk, but the higher the potential return. You also need to bear in mind the price of shares in an investment trust can go up or down so you could get back less than you invested.
The level of risk and return will depend on the investment trust you choose. Its important to know what type of assets the trust will invest in, as some are riskier than others.
In addition, look at the difference between the investment trust’s share price and the value of its assets, as this gap may affect your return. If a discount widens, this can depress returns.
You need to find out if the investment trust borrows money to buy shares. If so, returns might be better but your losses greater. With a split capital investment trust, the risk and return will depend on the type of shares you buy.
As of April 2016, all individuals are eligible for a £5,000 tax-free Dividend Allowance (this tax-free allowance will fall to £2,000 in April 2018). Dividends received by pension funds or received on shares within an Individual Savings Account (ISA) will remain tax-efficient and won’t impact your dividend allowance.
Many unit trusts can be held in an ISA. In this case, your income and capital gains will be tax-efficient.
Any profit you make from selling shares outside an ISA may be subject to Capital Gains Tax.