Chapter 7: Investment Trusts (5)

Question 1

What is an Investment Trust?

Answer 1

A company, with directors and shareholders.

Question 2

What do Investment Trusts do?

Answer 2

Invests in a diversified range of investments, allowing shareholders to diversify and lessen risk.

Question 3

When are shares issued to new investors?

Answer 3

When a new investment company is established.

Question 4

How many shares are offered to new investors?

Answer 4

A fixed number of shares, likely to remain fixed for many years.

Question 5

What sort of companies are Investment Trusts?

Answer 5

Close-ended companies.

Question 6

Where does the cash from the primary issue of shares go?

Answer 6

Will be invested in a number of other investments. If the value of these investments grows, then the value of the investment trust company’s shares should rise too.

Question 7

What is an investment company called if it has more than one type of share?

Answer 7

Split-capital investment trusts.

Question 8

How does an investor receive their return on Zero-Dividend Preference (ZDP) shares?

Answer 8

ZDPs receive no dividends, so the investor receives their return via the difference in the price they paid and the amount they receive when the ZDP is repaid at a fixed future date.

Question 9

What are Real Estate Investment Trusts (REITs)?

Answer 9

Investment companies that pool investors’ funds to investors funds to invest in commercial and residential property.

Question 10

When did REITs become available to UK investors?

Answer 10

January 2007.

Question 11

What is one benefit of REITs?

Answer 11

• Provide access to property without previous disadvantage of double taxation.

Question 12

Explain the benefit of REITs previously mentioned.

Answer 12

A REIT pays no tax on property income or capital gains on property disposals, providing at least 90% of that income is distributed to shareholders each year. These property income distributions are then taxed in the hands of the investor.

Question 13

Where may REITs be held?

Answer 13

• ISAs
• Self-invested personal pensions schemes (SIPPs)

Question 14

What are the benefits of REITs to investors?

Answer 14

• Access to professional property investment - allows investors to diversify the risk of holding direct property investments.
• This type of investment removes risks associated with holding direct property, e.g. liquidity risk or risk the investment won’t be readily realised.

Question 15

Where are REITs quoted?

Answer 15

Like other investment trusts, quoted on the LSE.

Question 16

What is Gearing?

Answer 16

Where investment companies borrow money on a long-term basis by taking out bank loans or issuing bonds. Then, invest borrowed money in more stocks and shares.

Question 17

What are the benefits of gearing?

Answer 17

Improves returns when markets rise, but can exacerbate losses when markets fall.

Question 18

What is the relationship between gearing and risk?

Answer 18

Greater the level of gearing, the greater the level of risk.

Question 19

What is the share price of an investment trust based on?

Answer 19

What someone is willing to pay for it (demand and supply).

Question 20

Is the share price the same as the value of the underlying investments?

Answer 20

No.

Question 21

What is the Net Asset Value (NAV)?

Answer 21

The value of the underlying investments determined on a per share basis.

Question 22

What’s it known as if the share price is trading above the NAV?

Answer 22

Share prices are trading at a premium.

Question 23

What’s it known as if the share price is trading below the NAV?

Answer 23

Share prices are trading at a discount.

Question 24

What does a discount show?

Answer 24

A discount is a function of the market’s view of the quality of the management of the investment portfolio, and its choice of underlying investments.

Question 25

When is a smaller discount/premium displayed?

Answer 25

When investment trusts are nearing their winding up, or about to undergo some corporate activity such as a merger/takeover.

Question 26

Where are investment trust companies traded?

Answer 26

On the LSE using the SETS trading system or via a retail service provider (RSP).

Question 27

Where do OEICs and Investment companies differ?

Answer 27

• ITs are close-ended whereas OEICs are open-ended.
• ITs can use gearing.
• Share price of OEIC and Unit Trust based on underlying value of constituent investments, whereas ITs are based on demand and supply.