1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 50:  Investment trusts  Characteristics of investment trusts  Real Estate Investment Trusts  Characteristics of REITs  Benefits and risks 50cis

2. What is an investment trust? Despite its name, an investment trust is not a trust at all. It is actually a company, with directors and shareholders, and it is listed on a stock exchange. The main similarity between an investment trust and a unit trust is that it invests in a diversified range of investments. This allows shareholders to diversity and lessen their risk.  Upon launch, an investment trust issues shares to new investors  However, the investment trust is not open-ended. The number of shares in issue is likely to remain fixed for many years.  The cash from the issue of shares by an investment trust is usually invested in the shares of other companies  If the value of those investments goes up, the value of the shares in the investment trust would go up too.  As they are closed-ended, investment trusts are very different from unit trusts and OEICS. There are over 400 investment companies, which include investment trusts, offshore investment companies, Venture Capital Trusts (VCTs) and split capital companies, many of which have existed for more than 50 years (Source: AIC)  Because investment trust share prices are affected in part by supply and demand, their value can fluctuate more often than units in unit trusts

3. Investors trading in the investment trust company’s shares have no effect on the underlying investment portfolio. The fund manager will invest and manage a fixed pool of money which enables the fund manager to plan ahead. Characteristics of investment trusts  This is especially useful for those investment companies with investment objectives which specialise in more illiquid assets such as smaller companies, emerging and developing markets and unlisted investments.  With a unit trust, when money flows into the fund, the fund manager has to invest it. Investment companies are listed on the stock market, which means that the shares of the company are traded on a stock exchange, just like the shares of other companies.  Unlike unit trusts, investors can deal in the shares at any time. They do not have to wait for the daily price to be fixed.  In this respect, investment trusts are similar to exchange-traded funds The most common UK listing for investment trusts is on the London Stock Exchange’s 's Main Market.

4. Some investment trusts have more than one type of share. For instance, they can issue ordinary shares and preference shares Characteristics of investment trusts The preference shares can be issued on different terms:  Convertible preference shares  Convertible into ordinary shares after a pre-determined date  No dividends, but the investor receives a return in the form of the difference between the price paid and the price when the ZDP is redeemed at a fixed future date  The greater the gearing  The greater the performance when the market is rising  The greater the downside when the market is falling Because they are PLCs, investment trusts can also borrow more money on a long-term basis by taking out bank loans or issuing bonds. This process is known as gearing.  Zero dividend preference shares Aberdeen Development Capital 2010 ZDP Shares (ADC2)

5. Holder of unit trust units have very little say in the running of the fund. They can only vote with their feet (i.e. take their money out of the fund). Investors in investment trusts are shareholders of the company and have considerably more power. Advantages of investment trusts (cont.)  There are various reasons why a company's shares trade at a premium or discount to NAV: The prices of unit trusts are calculated depending on the value of their assets, so you cannot buy them at a discount.  They can vote at shareholder general meetings  The investment trust has a board of directors which is responsible to the shareholders for the running of the investments  market sentiment towards a particular type of investment or market the company invests in;  past performance under a particular manager or board;  the market's belief that the NAV of the company is not reflecting a fair value or in some cases this may be due to the market not understanding the true value of the company. The market value of the share may be different to the net value of all the underlying investments held by the company (the NAV). The difference between the market price and the net asset value is known as a discount or premium to NAV. More often than not, an investment trust's shares tend to trade at a 'discount' i.e. when a share price is lower than the NAV per share.

6. Investment trusts: premiums and discounts to NAV Many investors prefer the certainty of being able to buy and sell at the value of the assets (it's certainly more useful for a tracker fund). But if you can buy an out-of-favour investment trust at a discount, you may see that discount narrow as it comes back into favour. The charts show the price (black line), NAV (red line) and discount (green line in bottom chart) for the Aberdeen New Dawn Investment Trust, As you can see, during the sell-offs of the Asian crisis, the dotcom (TMT) crash and the Credit Crunch, the discount expanded significantly. But the discount narrowed during bull markets and even went to a premium in 2006-2007. This kind of behaviour makes closed-end funds an especially appealing way to invest after a crash.

7. Investment trusts: costs  With an investment trust, investors have to pay stockbroker commissions  Open-end funds typically charge an entry fee of up to 5% of your investment.  Annual management charges vary, but range from around 0.5% for a tracker to around 3% for more specialist products.  Unit trusts also sometimes charge withdrawal fees of 2.5% or so. Investment trusts can be a cheaper way for small investors to gain exposure to a diversified range of investments Investment trusts Unit trusts The latest survey for the Association of Investment Companies (AIC) found that 25% of trusts have total expense ratios of under 1%, while 55% have total charges of under 1.5%. By contrast, the most recent survey of unit trusts and OEICS found their average annual charge is 1.62%.  Annual management charges vary again but are typically around 1%-2%.  There's also a bid-offer spread on the trust's share price.  That's the difference between the price at which you can sell (the bid price) and the price at which you can buy (the offer price).

8. Investment trusts: no closet trackers  Investment trust fund managers can take the “long view” when investing The money invested in an investment trust is permanently locked up in the company until the company is dissolved, the creditors paid out and any remaining cash returned to the ordinary shareholders Therefore, the fund manager does not have to fear sudden withdrawals of money from the investment fund by panic-stricken investors reacting in a knee-jerk fashion to falls in the market.  They can take a contrarian view of the market, even if it means their fund performing significantly worse than the market in the short term o They need not fear withdrawals of cash by the investors. Investors can only sell their shares to someone else: this has no impact on the size of the fund  Many unit trust fund managers dare not take the “long view”  Many of them play safe by quietly tracking the index with their investments. o This ensures that their fund never under- performs the index by a wide margin This chart shows a typical open-end fund versus the benchmark for its market. It is run by a major fund group and charges a 5% entry fee and a 1.5% management fee.  Why pay high fees for this performance rather than an annual TER of around 0.5% and a few pounds in brokers' commissions for an ETF that tracks the same index?

9. £100 invested would be worth… 1 year3 years5 years10 years Unit trust / OEIC ave. performance £110£148£189£182 Investment trust ave. performance £115£183£272£247 Average performance figures show investment trusts consistently outshone unit trusts and OEICs over the 10 years to 2007 Source: AIC and Morningstar figures show the average value of £100 invested over various periods to 1 October 2007; unit trust/OEIC performance on bid-to-bid price basis, with net income reinvested, investment trust performance on mid-price basis with net income reinvested. Investment performance: how do they compare? Various reasons are put forward for the better performance of investment trusts. One is that investment trusts benefit because they are closed-ended, so they do not have to sell any of their investments if investors want their money back. Unit trusts and OEIC managers, on the other hand, can be forced into selling some of their best investments if investors want to withdraw their money.  A more likely reason over the last decade is the use of gearing by investment trust managers.  By being able to borrow money to invest they did particularly well when stock-markets began rising after the 2000- 2003 bear market.

10. What is a real estate investment trust? “Real estate” means immovable property, such as land and/or buildings and all other permanent fixtures such as walls, roads and fences Real estate investment trusts (REITs) are investment trust companies which invest in commercial and – sometimes – residential property. REITs have existed in other countries for many years. But it was only in January 2007 that tax changes made them possible to exist in the UK  REITs can be held within ISAs and Self-Invested Personal Pension Plans (SIPPs)  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  The investors in the REIT is 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 give investors access to professional property investment  REITs enables investors to investor in commercial property with relatively small amounts of money UK REITs Source: REITA.org

11. REITs on the London Stock Exchange The main quoted property companies the UK, such as Land Securities and British Land, have converted to REIT status. There are now over 20 REITs listed on the LSE with a market capitalisation of approximately £20bn. Investors buy and sell REITs in the same way they would any other share. This makes property a much more liquid investment, as it can take years for individual buildings to be sold.  However, property has been a major casualty of the Credit Crunch so investor returns since the launch of this new asset class have been negative.