Fantastic four: funds with superpowers
My daughter’s favourite question at the moment is “Which superhero do you like best?” Her next...
Last week Kylie Jenner became Forbe’s youngest “self-made” billionaire. While I have some doubts if it’s truly ‘self-made’ – having grown up in front of the whole of America on the famous ‘Keeping up with the Kardashians’ reality show – it’s still quite the accomplishment to achieve by age 21, especially when you consider that only 12% of the 2019 Forbes World’s Billionaires list are women. Not to mention the fact that 73% of male billionaires are self-made, compared to 27% of female billionaires.*
While you might not be making billions with your twenty year-old ISA account, more and more individuals are becoming “ISA millionaires” according to The Telegraph. But where are they investing their money? The report suggests that high-wealth individuals tend to opt for investment trusts over funds.
In the hopes of becoming a millionaire before I’m sixty, I thought I would take a closer look at what exactly an investment trust is, and how I can use them in my own ISA.
‘Money is not the only answer, but it makes a difference.’
-Barack Obama, 44th President of the United States
An investment trust is a publicly-listed company, just like BT or Shell. Whereas BT’s business model is to make money for shareholders by providing telecommunications services and Shell supplies oil and oil-related services, an investment trust invests in other companies. They are a type of fund.
However, when buying a ‘regular’ fund, you’re buying units that the manager can create to meet demand. Because more units can be created at any time, ‘regular’ funds are known as ‘open-ended’. With an investment trust, there is a set number of shares and you can only buy them when someone else sells them. So investment trusts are ‘close-ended’ funds.
Investment trusts have four distinguishing attributes that you’ll need to understand before investing. The first is an independent board. The board members act on behalf of shareholders, hopefully providing investors with an extra layer of protection.
The second is dividend smoothing. Unlike an open-ended fund, an investment trust can hold back up to 15% of its generated income for a rainy day – this is known as holding ‘revenue reserves’. The reason for doing this is known as ‘dividend smoothing’ or, in other words, being able to pay out a steady and rising level of income to investors, regardless of the investment backdrop.
Next is gearing. This means that trusts can borrow money to invest on behalf of shareholders. This can boost returns during rising markets or if the trust’s underlying portfolio does well. However, investors should be aware that gearing can also leave the investment trusts susceptible to greater losses during falling markets or periods of difficulty.
The last terms you’ll often to see are ‘discounts’ and ‘premiums’. Trusts can trade on either discounts or premiums to their net asset value. Essentially, this means they can be either cheaper or more expensive than the face value of their portfolio of investments.
Research from the Associate of Investment Companies (AIC), to mark the 20th anniversary of the ISA, shows that if an investor had invested each year’s maximum ISA allowance from 1999 to 2018 – an investment of £206,560 in total – ten investment companies would have provided a pot of money worth more than £845,000 today. Not quite a million, but not far off.
Scottish Mortgage, which invests in companies from around the globe: £932, 615
Baillie Gifford Shin Nippon, the Japanese Smaller Companies trust: £888,326
TR Property, which invests in UK and European property securities: £845,173
Like all good things in life, it’s about balance and diversification. When it comes to investment it’s key not to have all your eggs in one basket – that’s true for across asset classes, geographical location and even funds and trusts.
As Annabel Brodie-Smith, Communications Director of the AIC said: ”ISAs are 20 years old this year and it’s impressive to see how well so many investment companies have performed over that period. Of course, it’s interesting to see the best performers, but it’s important to have a diversified and well-balanced portfolio which suits your needs.”