2 pros and 2 cons of investing through an investment trust

An investment trust is a common way for people to buy into existing portfolios of managed investments. Our writer weighs some potential pros and cons.

Posted by Christopher Ruane

Published 27 October

SMT

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

There are lots of different ways to put money into the stock market. One is to buy shares (or even a single share) in an investment trust.

Investment trusts come in all shapes and sizes but basically they are pooled investment vehicles. Think of an investment trust as a company listed on the stock market that has investing as its own business.

Each trust needs to be considered on its own merits. But at a high level, there are some potential pros and cons of buying into an investment trust, as I see it. Here are a couple of each.

Diversification

Even a private investor with a small amount to put in the market ought to reduce their risk by spreading it over multiple investments.

That can be hard to do on a very limited budget – but an investment trust can offer a potential solution.

Take Scottish Mortgage Investment Trust (LSE: SMT) as an example. Its share price is currently below £12.

But its portfolio spans dozens of companies. They include listed tech giants like Meta Platforms and Nvidia. They also include unlisted companies a small private investor may otherwise struggle to invest in, such as SpaceX (Scottish Mortgage’s biggest holding right now).

By buying just one share in Scottish Mortgage, an investor would get access to a diversified portfolio.

Professional management

Over the long run, Scottish Mortgage has been a runaway success story. It has not cut its dividend per share for almost a century.

The investment trust’s share price has moved up 16% over five years, but that has included periods of significant volatility. It is up 80% since October 2020, for example – but still 24% beneath its price back in November

Why has Scottish Mortgage been so volatile? Its focus is on growth companies. As their prices have moved around a lot, so has Scottish Mortgage’s.

The investment trust has professional fund managers who help decide what shares to buy and sell. Expert managers can offer skills and experience a private investor lacks. But not all managers are equally good.

Still, in many cases I think an investment trust having a team of professional stock pickers can help make it more attractive.

Regular fees

Who pays for that? After all, fund managers do not usually come cheaply no matter how good or bad they turn out to be!

Above I said an investment trust is a listed business (that just happens to be a pooled investment). So it needs to pay costs like staff wages.

To do that an investment trust typically levies an annual management fee. That can be modest, but over the long term can add up.

Imperfect pricing

Being listed in its own right also brings another possible disadvantage (though it can actually work to investors’ advantage too).

The stock market price for an investment trust reflects what investors are willing to pay for it. That can differ from a ‘sum of the parts’ valuation (or what is known as the net asset value).

For example, Scottish Mortgage currently trades at a 12% discount to its net asset value.

That may frustrate shareholders, who think the market undervalues their holding. Seen as a cup half-full, though, such discounts may offer investors a chance to buy something for less than its value.