Investment trusts remain one of the most underutilized yet powerful tools for wealth building. Unlike mutual funds or ETFs, they combine the benefits of pooled investments with the flexibility of stock trading. In this guide, I break down how investment trusts work, why they matter, and how you can use them to grow your wealth steadily over time.
Table of Contents
What Are Investment Trusts?
Investment trusts, also known as closed-end funds, are publicly traded companies that invest in a diversified portfolio of assets. They issue a fixed number of shares, which trade on stock exchanges like any other stock. Unlike open-end mutual funds, which create or redeem shares based on demand, investment trusts have a fixed capital structure.
Key Features of Investment Trusts
- Closed-end structure: The number of shares remains constant unless the trust issues new ones.
- Leverage: Some trusts borrow money to enhance returns, which can amplify gains (or losses).
- Discounts/Premiums: Shares can trade below (discount) or above (premium) the net asset value (NAV).
- Dividends: Many trusts distribute income regularly, making them attractive for income-seeking investors.
Why Investment Trusts Stand Out
1. Potential for Discounted Purchases
Investment trusts often trade at a discount to NAV. If you buy at a discount, you effectively purchase assets for less than their market value. For example, if a trust’s NAV is \$20 per share but trades at \$18, you get a 10\% discount.
2. Active Management with Lower Costs
While ETFs track indexes passively, investment trusts are actively managed, yet their expense ratios are often lower than mutual funds.
3. Dividend Smoothing
Some trusts maintain dividend reserves, allowing them to pay consistent dividends even in lean years.
How Investment Trusts Compare to Other Investment Vehicles
| Feature | Investment Trusts | Mutual Funds | ETFs |
|---|---|---|---|
| Structure | Closed-end | Open-end | Open/Closed |
| Trading | Stock exchange | Fund company | Exchange |
| Pricing | Market-driven | NAV-based | NAV-based |
| Leverage | Common | Rare | Rare |
| Costs | Moderate | High | Low |
Calculating Returns: A Practical Example
Suppose you invest \$10,000 in an investment trust trading at a 5\% discount to NAV. The NAV is \$50, but shares trade at \$47.50.
- Number of shares bought:
If NAV grows to \$55 and the discount narrows to 2\%:
- New share price: \$55 \times 0.98 = \$53.90
- Portfolio value: 210.53 \times \$53.90 \approx \$11,347.37
- Return: \frac{\$11,347.37 - \$10,000}{\$10,000} = 13.47\%
This illustrates how discounts and NAV growth work together to enhance returns.
Risks to Consider
- Discount Volatility: Discounts can widen unexpectedly.
- Leverage Risk: Borrowing magnifies losses in downturns.
- Management Risk: Poor decisions can erode returns.
How to Select the Right Investment Trust
- Check Historical Discounts/Premiums – Buying at a wider-than-usual discount improves margin of safety.
- Assess Management Track Record – Look at long-term NAV growth.
- Review Fees – High expenses eat into returns.
- Understand the Portfolio – Sector concentration adds risk.
Final Thoughts
Investment trusts offer a unique blend of flexibility, income potential, and value opportunities. While they require more due diligence than ETFs, their structural advantages make them worth considering for long-term wealth building. By understanding discounts, leverage, and management quality, you can harness their potential effectively.
