What is an Investment Trust Fund?
An investment trust is a publicly listed financial institution, which is a closed-end fundClosed-end FundA closed-end fund refers to a professionally managed fund whereby an investment company issues the initial public offering to raise capital. Later, these stocks are exchanged in the open market among the shareholders like other shares. Such investments provide better returns than the open-end funds. (CEF) that invests in shares or financial assets on behalf of its investors or other organizations. The value of the amount of money invested in an investment trust is dependent on the demand and supply for the invested share or financial asset and the underlying value of the assets that are owned.
For an investor who is looking at profits with minimal risk, It is the best option since it allows investing in a plethora of shares rather than putting all of the investment into one company’s share. Although the risk of losing out on investment due to the performance of one share would not hurt the investor, he/she will be in a better position, having invested in other shares in the fund, which might have a better performance.
Factors Impacting Investment Trust Fund
Investment trust functions on the basis of the market. If the market performs well, so will the investment trust’s fund. The investment trust fund manager needs to be able to gauge market conditions and enter or exit a position that is favorable or unfavorable. As a result, It has an inherent riskInherent RiskInherent Risk is the probability of a defect in the financial statement due to error, omission or misstatement identified during a financial audit. Such a risk arises because of certain factors which are beyond the internal control of the organization. of losing out on the investment if the right decisions are not made at the right time. Below are the two main factors that decide the value of the investment trust.
- #1 – Supply and Demand for Shares and Assets – Since they hold a fixed amount of shares and assets, the supply and demand of the shares and assets held in the investment trust affect the value of the underlying assetsUnderlying AssetsUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates..
- #2 – Performance – The performance of the assets and shares in the investment trust majorly impacts the value of the money invested. Since the money is invested in a variety of assets and shares, the value of the investment trust will not plummet or soar in a short span.
Example of Investment Trust
Let’s discuss an example.
Let’s assume that you invest $1,000 in XYZ investment trust today. The money that is received by the investment trust is pooled along with the investment of other investors to purchase a diverse range of products, including shares, bondsBondsA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually., and other financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash..
- You invest $1,000 in an investment trust.
- XYZ investment trust pools the $1,000 you invested with money invested by other shareholders into a single pot, which is the ”Fund”.
- This ”Fund” is ultimately used to buy shares and other financial assets by the ”Fund Manager”.
- Since the money is invested in the open market, the shares and financial assets are bought and sold depending upon the market conditions to seize the right opportunity to earn maximum profits out of the invested shares and assets. This job is done by the fund manager.
- The shares that you own can be sold in the open market at the market price, and in this way, you can generate your own profit out of your investment. The investment of $1,000 can increase or decrease depending on the shares and financial assets that the fund manager has invested in.
Some of the advantages are as follows:
- They allow investing in a plethora of shares and other financial assets.
- Good for investors who are looking for low-risk long term investment options.
- They pay dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company., and the investor can earn at regular intervals from his / her investment.
Some of the disadvantages are as follows:
- To gain a considerable amount of returns from the investment, it requires a substantial amount of time for which the money invested needs to be locked out, which can be a minimum of five years or more.
- They are totally dependent on the market and can result in a loss of investment.
- Highly dependent on the decisions of the fund manager; hence the investor can have no control other than exiting from the investment completely.
- The profit and dividend gained from investment trust are taxable and hence can reduce the actual returns that are gained from the investment.
- Investing in an investment trust fund allows the investor to gain ownership of the share or the financial asset that the money invested in.
- In theory, the returns from investing in an investment trust can be humungous whereas, in reality, the returns are reliant on the performance of the share and assets in the investment trust and the market demand and supply of the shares and assets in the market.
- Most they pay dividends for the shares usually once or twice a year, whereas investment trusts with an astounding performance can pay dividends on a monthly basis.
- The dividends and the profits earned from an investment trust are taxable.
- Gearing is a term that refers to borrowing money to invest more. Their fund managers can borrow money to invest more into the fund so that the returns are much higher and to get better leverage to pay for the borrowed amount.
- They are closed-end trust since it holds only a fixed amount of shares which can be bought by new investors from the existing shareholders in the trust.
- It differs from a unit trust, where the investor is assigned a unit of the share and is not the shareholder of the unit trust. The unit refers to the investor’s investment in the investment portfolioInvestment PortfolioPortfolio investments are investments made in a group of assets (equity, debt, mutual funds, derivatives or even bitcoins) instead of a single asset with the objective of earning returns that are proportional to the investor's risk profile..
- In the same way, it is different from a mutual fundMutual FundA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks. that issues units for the shares in which the amount is invested and not the owner of the share.
- Supply and demand for the investment trust can be a risk to the investment since a falling market will only make it difficult for the investor to sell his investment at a higher price, thereby resulting in a loss.
- Investing in an investment trust involves low risk, and the investor can expect to earn from the investment at regular intervals in the form of dividends.
This has been a guide to what is an investment trust and its definition. Here we discuss the factors that decide the value of investment trust fund along with an example, advantages, and disadvantages. You can learn more about auditing from the following articles-