An investment trust is a company with a set number of shares. It is allowed to borrow money to invest (called gearing). Unlike an open-ended investment fund, an investment trust is closed ended. This means there are a set number of shares available, and this will remain the same no matter how many investors there are. This can have an impact on the price of the shares and the level of risk of the investment trust. Open-ended investment funds create and cancel units depending on the number of investors.

You can invest a lump sum by buying investment trust shares direct from the investment-trust company or through a financial adviser, stockbroker or private client manager – see Related links. Alternatively you can save on a regular monthly basis through the investment trust company (investment-trust savings scheme).

The price of the investment trust shares depends on two main factors:

This second point applies to investment trusts but not to open-ended investment funds or life assurance investments. The reason is because they are closed-ended funds. The laws of economics say that if there is a high demand for something, but limited supply, then the price goes up. So, if you own some investment-trust shares and there are lots of people queuing up to buy them then you can sell them for more money. On the other hand, if nobody seems to want them then you will have to drop the price until someone is prepared to buy.

The result is that investment trust shares do not simply reflect the value of the underlying investments, they also reflect their popularity in the market. The value of the investment trust’s underlying investments is called the net asset value (NAV). If the share price is exactly in line with the underlying investments then it is called trading at par. If the price is higher because the shares are popular then it is called trading at a premium and if lower, trading at a discount. This feature may make them more volatile than other pooled investments (assuming the same underlying investments).

There is another difference that applies to investment trusts – they can borrow money to invest. This is called gearing. Gearing improves an investment trust's performance when its investments are doing well. On the other hand, if its investments do not do as well as expected, gearing lowers performance.

Example

If the investment trust is made up of £50m of investors' money and £50m of borrowing then the total fund available for investment is £100m.

Say the value of the fund goes down by 10% as a result of losses in the stock market – the value of the overall fund falls from £100m to £90m.

However, bear in mind that the borrowing is still £50m, therefore the remaining £40m belongs to the investors.

So, although the overall fund went down by 10%, the investors' money part has actually gone down by 20% (ie from £50m to £40m). Gearing boosts gains, but it also magnifies losses.

Not all investment trusts are geared and deciding whether to borrow and when to borrow, is a judgement the investment manager makes. A gearing figure of 100 means that an investment trust is not geared. Any figure over 100 shows the proportion of its total investments that is borrowed. For example, a gearing figure of 120 means that borrowed money amounts to one-sixth of a trust's total investments.

An investment trust that is geared is a higher-risk investment than one which is not geared (assuming the same underlying investments).

Splits are a type of investment trust that sell different sorts of shares to investors depending on whether they are looking for capital growth or income. They run for a fixed term. The shares will have varying levels of risk, as some investors will be ahead of others in the queue for money when the trust comes to the end of its term.

You usually pay dealing charges when you buy and sell investment-trust shares, and the difference between the prices at which you buy and sell (the bid/offer spread) is effectively another charge. There is also an annual management fee which comes out of the investment fund.

The tax position is largely the same as for open-ended investment funds. You should be aware that tax legislation changes constantly and you should find out the most current position.

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