CISI – Financial Products, Markets & Services Topic – Investment Funds (7.5 Investment Trusts)

What is an investment trust? Investment Trusts are set up as a company NOT a trust Board of Directors Uphold the best interest of the investors Usually independent of the Investment Manager Meet on a regular basis to ensure the objectives of the trust are being met Investment Manager In charge of the day-to-day running of the investment trust Decide where to invest the money held by the trust and when to sell holdings Invests in a diversified portfolio to lessen risks The cash from the issue of shares is invested in a number of investments (Usually shares in other companies) Set-up as a listed company with the number of shares issued remaining fixed for many years (Closed-ended) Investment Trusts If the value of the investments grows, the value of the investment trust’s company shares should rise too. Dividends are also paid to shareholders. Shareholders Buy shares in the investment trust via the stock exchange to buy into the fund They can vote to remove members from the board of directors.

Gearing Unlike OEICs and unit trusts, Investment Trusts are listed companies (PLCs), and can therefore borrow more money on a long-term basis by: Taking out bank loans or Issuing bonds This process is known as gearing This approach can: Improve returns when markets are rising, but Exacerbate losses when markets are falling The greater the level of gearing, the greater the level of risk

Gearing The greater the level of gearing, the greater the level of risk Gearing Improves returns when markets are rising The greater the proportion of debt, the more gains are magnified to shareholders 100% Equity 50% Equity, 50% Borrowing Gearing Exacerbates losses when markets are falling The greater the proportion of debt, the more losses are magnified to the shareholders 100% Equity 50% Equity, 50% Borrowing

Real Estate Investment Trusts (REITS) Investment Manager Uses their professional expertise to make decisions on investing in commercial and possibly residential property using investors’ money PROPERTY Real Estate Investment Trusts (REITS) Money is generated via the rental and disposal (sale)of the property held in the REIT Buy shares In the REIT Via a stock exchange Gains paid to shareholders Investors

Advantages of indirect investment in property over direct investment In groups, make a list of the advantages which indirect investment in property (via REITs) holds over direct investment in property. Diversify the risk of holding direct investments in property Removes the liquidity risk associated with direct investment in property Enables investment in commercial property with relatively small sums of money Gains access to professional property investment Avoids double taxation Investors

Real Estate Investment Trusts (REITs) Tax Rules Provided that 90% of the income (after expenses) is distributed to shareholders, REITs pay no corporation tax on property income (i.e. rentals), nor capital gains tax on property disposals When income distributions are handed to investors, they are then taxed in the normal way, as if the investor had received the property income directly. It is not taxed as a dividend. This avoids double taxation REITs can be held within ISAs and Self-Invested Personal Pension Plans (SIPPs) REITS are quoted on the LSE and have been available in the UK since January 2007

“Trading at a discount” Pricing, Discounts and Premiums The price of shares in investment trusts are not based on the net asset value of the underlying investments like an OEIC. “Trading at a premium” This is when shares in an investment trust are trading above the net asset value Net Asset Value (NAV) “Trading at a discount” This is when shares in an investment trust are trading below the net asset value Generally, most investment trust company shares trade a discount. The extent of the discount is calculated daily and is shown in the business pages of most newspapers

Pricing, Discounts and Premiums Activity Three scenarios involving the pricing of investment trusts are set-out on your worksheet. Attempt to answer the questions by: Identifying whether the shares in each example are trading at a premium or discount to the Net Asset Value. Calculating the percentage premium or discount in each example. If you finish, attempt the extension questions over the page.

Comparing Collective Investment schemes Authorised Unit Trusts OEICs Investment Trust/REITs Legal Structure Trust Company Management Authorised Manager Authorised Corporate Director Board of Directors Supervision Trustee Depository Regulation FCA UK Listing Authority Open or Closed-ended Open Closed Pricing Single or Dual-priced Dependent on demand and supply Trading Stock Market Settlement CREST