What is the difference between an investment trust and an investment company?
Both run closed-ended funds with fixed capital structures and sell their shares on the stock market.
They take investors' money and pool it to purchase a spread of investments.
Nowadays, the different labels are used mainly to distinguish between onshore investment companies (investment trusts) and offshore versions (investment companies).
Q: So how did investment trusts become so named?
A: It is a relic of the past. Investment trusts date back to 1868. Some of the earliest investment trusts were legal trusts, while others were structured as companies from the start.
John Newlands explains what happened next in his history of the investment trust industry, Put Not Your Trust in Money.
He writes: "Following a legal test case - Sykes v Beadon, 1878 - investment trusts were directed to convert to the company form or face being compulsorily wound up.
"This threat caused the trusts to turn themselves into investment trust companies as quickly as they could - only to find, having done so, that the Sykes v Beadon judgement was reversed on appeal.
"In the meantime, however, the company form had been found to have several advantages, such as the ability to borrow money to enhance investment returns.
"There was no going back, and the formal title investment trust company prevailed, as did the informal abbreviated title investment trust."
Q: Does the term investment trust have any legal relevance?
A: The term is still used by the UK tax authorities. For investment companies to be exempted from paying tax on the capital gains they make from the sale of investments in their portfolios, they must be deemed an 'approved investment trust company'.
This means they must satisfy certain legal requirements, such as having a spread of investments, trading their shares on the stock market and not retaining more than 15% of their annual investment income.
An approved company can call itself an investment trust (but doesn't have to), but an unapproved offshore investment company cannot.
Q: Why have some investment companies set up offshore?
A: Mainly because of the types of assets they invest in and for income flexibility. Until recently, approved investment trust status was only open to companies distributing income from shares.
Companies investing in areas such as property, infrastructure and hedge funds did not qualify. However, after changes to the rules and the introduction of real estate investment trusts, there is no longer a problem, so many investment companies have moved back onshore.
Q: How do the differences between investment trusts and offshore investment companies affect investors?
A: When you buy shares in an investment trust, you have to pay government stamp duty of 0.5% on top of the price of the shares. There is no stamp duty to pay if you buy shares in an offshore investment company. Otherwise, there are no tax differences.
Q: Is there any difference in the level of protection offered?
A: Neither onshore nor offshore investment company investors are covered by the Financial Services Compensation Scheme. However, if a regulated adviser mis-sells shares in either type of company, investors will be covered.
Reassuringly, investment companies must have independent boards of directors, who are there to protect shareholders' interests, while offshore companies are based in the Channel Islands, where corporate governance is seen as being on a par with that in the UK.
Q: Will the term investment trust continue to be used?
A: In 2006, the Association of Investment Companies (AIC), then known as the Association of Investment Trust Companies, stopped using the word trust, to make its membership more attractive to offshore investment companies. The AIC nowadays uses the term 'investment company' as a catch-all.
However, it believes the term investment trust will continue to be used in common parlance to describe closed-ended funds onshore.
This story was originally written for our sister magazine, Money Observer.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.