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| Foreign & Colonial Investment Trust (Photo credit: bikertect) |
What Constitutes an Investment Trust
The investment trust is a primarily British investment vehicle which falls within the area of investments known as collectives or collective investments. It does so because it provides a fund through which investors pool their money to collectively purchase shares in listed companies (also known as equities or stocks). As such the investors collectively share in the success, or otherwise, of the investment choices made by the expert fund managers who are responsible for running the funds. Under this broader definition they share similarities with other collective investments such as Unit Trusts and Open Ended Investment Companies (OIECs), however they are distinguished by a couple of key features which relate to their respective structures.
In contrast to unit trusts (which are run as funds by investment companies) investment trusts are distinct companies in their own right and they are therefore traded on stock markets in much the same way as a traditional plc. Consequently, they are what is classed as closed-ended as opposed to Unit Trusts and OIECs which are both open-ended. This means that an investment trust will, at any point in time, have a defined and fixed number of shares issued. For a new investor to purchase shares in an investment trust, another investor will have to sell their shares to them. Open-ended investments on the other hand allow investors to add their money to the fund so that the size of the fund grows - in exchange for their money the investor will be issued a number of new units based on the value of the fund’s exiting units.
This key difference also has an effect on the way in which the units/shares are valued. The value of an investment trust’s closed-ended shares are heavily dependent on supply and demand as investors buy and sell shares based upon the success of the funds investment choices. The units of open ended investments however are valued more directly as segments of the overall value of the fund (depending on the success of its underling investments).
Real Estate Investment Trusts
Also known by their abbreviation of REITs, these investment vehicles follow the basic idea of an investment trust in that they are companies specifically set up to invest in property or real estate rather than in other companies’ shares. As they do come under the general bracket of investment trust, UK REITS must be closed-ended and be publicly listed to qualify (although they can be privately held companies in other parts of the world). A specific characteristic of REITs, apart from the fact that they invest solely in real estate, is the requirement that 90% of the income the investment company makes must be re-distributed to its investors. Qualifying as a REIT does have the benefit of reducing the burden of corporation tax and so many investment companies have decided to convert to gain this status within the last decade.
One feature of investment trusts that is particularly salient for REITs is that they are allowed to borrow to facilitate the purchasing of assets and that, in the case of REITs, can mean mortgages being used to buy property assets.
In the next installment of this article we take a quick look at Split Capital Investment Trusts.
© Stuart Mitchell 2012
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