Understanding risk around Investment Trusts
Your questions answered
8 May 2015
When an investment trust uses gearing, what are the risks?
Gearing (borrowing) provides the investment manager with the potential to boost returns when they expect prices to rise by increasing their fund’s exposure to an underlying investment. If their judgement is correct, they will generate an additional return from gearing. The converse is true if the investment falls in value. The facility to borrow can also enable the investment manager to make new investments when they identify strong opportunities without having to sell existing holdings.
Not all investment trusts use gearing, and many of those that do use it to very modest levels.
Moreover, the level of gearing employed by an investment trust will generally vary according to the economic and market environment, however the industry average is 7%, according to the Association of Investment Companies (AIC).
As an investor, it is important to understand that while gearing can increase potential returns in a rising market, it can also magnify the extent of losses in a declining market. Also, a geared investment trust will fluctuate more than an equivalent non-geared fund and has the potential to deliver higher returns or greater losses.
How do the boards of investment trusts help reduce the risks for investors?
As a limited company (plc or ltd), an investment trust has an appointed Board of Directors who ensure that the fund is managed in the best interests of its shareholders. The role of the directors is to oversee the activities of the investment manager and other third parties appointed to provide services to the fund, and to ensure that the objectives of the investment trust are met.
Every year, directors are required to agree that the investment manager remains suitable to manage the fund’s assets. They have the power to change the manager if they believe it would be in the best interests of shareholders. They are also responsible for ensuring that expenses, including the investment manager’s fees, remain competitive.
How does the focus of an investment trust impact its risk profile?
If an investment trust is focused on a specific region or country, then it is important to be aware that certain geographies carry a greater risk than others. So, while an investment trust focusing on Asia could offer investors the potential for total return, it also carries additional risks. These include exchange rate volatility, which can cause the value of, and income from, an investment to rise or fall, and the fact that investments in the Far East are generally less well regulated than in the UK.
From a diversification point of view, trusts that invest in only one country can carry more risks than those spread across a number of countries. Similarly, funds that focus on a specific asset class, such as property, can also carry more risk than those which are spread across a larger number of sectors.
What benefits do investment trusts offer in reducing overall portfolio risk?
An investment trust provides access to a professionally managed portfolio of investments. This has the potential to give you a broad spread of investment opportunities, including access to different geographical regions and asset classes, and by diversifying your investment, can help to control the risk you are exposed to. Investment trusts can also help investors to diversify the asset mix within their portfolio, thereby reducing overall portfolio risk.
Is a long-term outlook the best risk mitigation technique where investment trusts are concerned?
Investment trusts are generally suited to investors who have a long-term time horizon since fund managers typically take a long-term view of the market in their investment strategies. In particular, those investing in funds specialising in the emerging markets and Asia should be aware of the higher degree of risk and the potential for short-term volatility. This kind of investment should therefore be seen as long-term in nature.
Please remember that the value of investments and the income from them may go down as well as up and you may not get back the amounts originally invested.
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Past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
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Issued in April 2015 by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.
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