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Investment trusts: the advantages and disadvantages

Investment trusts are often regarded as one of the best-kept secrets in the investment management industry. Traded on the stock market like regular stocks, these collective investment funds enable investors to gain exposure to a broad range of companies or assets in a cost-effective way.

However, like any investment, such trusts have their pros and cons. With that in mind, here’s a look at the advantages and disadvantages of them.

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Advantages

One of the main advantages of investment trusts is their cost-effectiveness. While you do have to pay trading commissions when you buy or sell (usually around £10 or so), what you avoid are the fund platform fees that investment providers charge when you hold regular open-ended funds. Hargreaves Lansdown, for example, currently charges 0.45% per year on open-ended funds for accounts with balances up to £250,000. Avoiding these kinds of fees can make a big difference to your wealth over time.

Investment trusts’ ongoing charges also tend to be quite attractive. For example, the City of London Investment Trust currently has a low ongoing charge of just 0.39%. There are not many open-ended, actively-managed funds with fees that low. Overall, investment trusts can be very cost-effective.

Another advantage of investment trusts is that they are closed-ended. This means that the portfolio manager of the trust has a fixed amount of capital to invest (although some trusts can use leverage). This is beneficial for a number of reasons. Firstly, because investors can’t suddenly demand their money back, portfolio managers don’t need to worry about holding cash for redemptions. This can minimise cash drag and potentially boost performance. Portfolio managers can also take a longer-term view. 

Investment trusts also have advantages when it comes to dividend payments as they are able to retain 15% of the income they receive each year and use the retained income to boost dividends in leaner years. As a result, many investment trusts have outstanding long-term dividend growth track records. City of London, for example, has increased its dividend every year for over 50 years now.

Finally, investment trusts are structured so that they have an independent board that is responsible for safeguarding investors. This is advantageous as it protects investors from issues such as poor-performing portfolio managers.

Disadvantages

On the downside, one issue to be aware of with investment trusts is that because of their closed-ended structure, they can trade at premiums or discounts to their net asset value (NAV). This can add complications. For example, a top-performing investment trust may trade at a significant premium, meaning you have to pay extra to acquire the assets in the trust. Similarly, a poor-performing trust may trade at a significant discount, which is not ideal if you’re already an owner of the trust (although it could be beneficial if you’re looking to buy).

Gearing (the ability to borrow to invest more) is another issue to consider with investment trusts. Not all of them use gearing, but plenty do. While gearing can boost gains when the market is rising, it can increase losses when markets are falling.

Overall, weighing up the advantages and disadvantages, investment trusts have considerable appeal, in my view. For those looking for cost-effective exposure to the stock market, I think they’re a great way to invest.

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Edward Sheldon owns shares in Hargreaves Lansdown. The Motley Fool UK has recommended Hargreaves Lansdown. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.