Investment Trusts Explained: Discounts, Gearing and When They Beat Funds

Investment trusts have been part of British investing since the nineteenth century, yet many people who happily buy funds and ETFs have never looked at one closely. They resemble funds, but they are companies listed on the stock exchange, so their share price can drift away from the value of what they own, and they are allowed to borrow to invest. This guide explains discounts, premiums and gearing, why the closed-ended structure matters, and when a trust can genuinely beat an open-ended fund.

Key Takeaways

Question	Short, Practical Answer
What is an investment trust?	A listed company whose business is investing, with a fixed pool of capital and an independent board overseeing the manager.
What is a discount?	The gap between the share price and the asset value per share (NAV). A NAV of 100p with a share price of 90p is a 10% discount.
Is a discount a bargain?	Not automatically. Discounts can persist or widen, and a wide one often reflects real doubts about the assets, costs or manager.
What does gearing do?	It magnifies returns both ways. With 20% gearing, a 10% portfolio move becomes roughly a 12% move in net assets.
When do trusts beat funds?	Mainly for illiquid assets such as infrastructure, private equity and property, where the manager is never forced to sell to meet redemptions.
Any extra costs?	Stamp duty, generally 0.5% on purchases of UK-listed shares, applies to most trusts but not to buying OEICs or ETFs.

1. What Is an Investment Trust?

An investment trust is a public limited company whose business is owning a portfolio of other investments. Despite the name, it is not a trust in the legal sense. It raises money by issuing shares, usually at launch, then invests according to a stated objective: global equities, UK smaller companies, infrastructure, private businesses and so on.

The shares then trade on the stock exchange. When you buy, you buy from another investor, not from the trust, so the trust’s pool of capital stays the same. That is what closed-ended means. Two features set trusts apart from most funds:

• An independent board. The directors are accountable to shareholders, appoint the investment manager and can replace it. They also set policy on gearing, dividends and the discount.
• Shareholder votes. You can vote at the annual general meeting on director re-elections and, for many trusts, periodic continuation votes on whether the trust should carry on.

2. How Trusts Differ From OEICs, Unit Trusts and ETFs

Open-ended funds (OEICs and unit trusts) create units when money comes in and cancel them when investors leave, usually dealing once a day at a price based on the underlying assets. ETFs are also open-ended but trade on an exchange, with specialist firms creating and redeeming units to keep the price close to asset value (our guide to index funds vs ETFs covers this). A trust has no such mechanism, so supply and demand set the price, and it can sit above or below portfolio value for long periods.

Feature	Investment trust	OEIC or unit trust	ETF
Structure	Closed-ended listed company	Open-ended fund	Open-ended, exchange-traded
Price you pay	Market price, can differ from NAV	Based on NAV, usually daily	Market price, kept close to NAV
Borrowing to invest	Allowed, within board limits	Very limited	Generally not
Income	Can hold back reserves to smooth dividends	Pays out income earned	Pays out or reinvests income earned
Stamp duty on purchase	Generally yes	No	Generally no

3. Share Price, NAV and the Discount

The net asset value (NAV) is everything the trust owns, minus its debts and other liabilities, divided by the number of shares. Trusts holding listed shares typically publish a NAV daily. Those holding private assets may only revalue quarterly or half-yearly.

• Illustrative discount: NAV of 100p, share price of 90p. A 10% discount: you pay 90p for 100p of assets.
• Illustrative premium: NAV of 100p, share price of 105p. A 5% premium: you pay 105p for 100p of assets.

The market price reflects sentiment as well as arithmetic. Trusts drift to a discount when their sector is out of favour, performance has been weak, investors doubt the asset valuations, the trust is small and thinly traded, or costs look high. Premiums appear where demand outstrips supply: a popular manager, a hard-to-access asset class or a fashionable strategy.

Read any discount in context: against the trust’s own history (10% means something different on a trust that usually trades at 3%), against its peers (if the whole sector has widened, the cause is sector-wide), and against recent news such as a manager departure or valuation write-down.

4. Why a Discount Is Not Automatically a Bargain

Buying at a discount has real advantages. Every 90p invested controls 100p of assets, so the income those assets produce is a higher yield on what you paid, and if the discount narrows you earn that on top of the portfolio’s return.

The reverse is also true. An illustrative example:

• You buy when NAV is 100p and the discount is 5%, paying 95p.
• A year later NAV has risen 10% to 110p, but sentiment has soured and the discount is 15%.
• The share price is now 93.5p. You are down about 1.6% even though your assets rose 10%.

Wide discounts are often justified: the market may doubt the valuations, dislike the fees or see the trust as too small. A discount that looks cheap can stay cheap for years.

A discount is a price, not a promise. It tells you what the market will pay for the assets today, not what you will receive when you sell.

Boards have tools to manage the discount:

• Share buybacks. Buying back shares below NAV nudges up NAV per share for remaining holders and adds a buyer to the market.
• Discount targets. Some boards commit to buybacks once the discount passes a stated level.
• Tender offers and continuation votes. A periodic exit at or near NAV, or a say on the trust’s future.
• Issuing shares. At a premium, new shares meet demand and stop the premium running too high.

An actively used policy tends to keep discounts narrower, though none guarantees a level.

5. Gearing: Borrowing to Invest

Gearing is borrowing to buy more assets than shareholders’ capital alone would allow, through a flexible bank facility or longer-term fixed-rate debt. It is usually expressed as a percentage of net assets.

An illustrative worked example, ignoring costs at first: a trust has £100 million of shareholders’ funds and borrows £20 million, investing £120 million. That is 20% gearing.

• Portfolio rises 10%: assets are £132 million. Less £20 million of debt, net assets are £112 million, up 12%.
• Portfolio falls 10%: assets are £108 million, net assets £88 million, down 12%.
• Portfolio falls 30%: assets are £84 million, net assets £64 million, down 36%.

Now add the cost. Borrowing £20 million at 5% a year means £1 million of interest, trimming about one percentage point a year from shareholders’ returns. Gearing only adds value if the extra assets earn more than the debt costs.

Gearing and the discount also tend to bite together, because falling markets usually widen discounts, so a geared trust’s share price can fall further than its portfolio. Levels vary: some trusts run little or no gearing, and some hold net cash.

6. Revenue Reserves and Dividend Smoothing

Open-ended funds must pass on the income they earn. Investment trusts can hold some back (within tax rules, broadly up to 15% of income in a given year) to build a revenue reserve, then draw on it in lean years to maintain or grow the dividend. Many can also pay dividends from capital profits, depending on their articles.

This is how some trusts have built very long records of rising payouts. The Association of Investment Companies publishes a list of “dividend heroes”: investment companies that have raised their dividend for at least 20 consecutive years. When many UK companies cut dividends in 2020, several trusts used reserves to keep paying.

Smoothing is useful if you rely on income, but it does not create money. For an income trust, check revenue cover (whether this year’s income covers the dividend), reserve depth (how many years of dividends the reserve could fund) and total return (whether NAV has grown alongside the dividend).

7. When the Closed-Ended Structure Beats a Fund

The strongest case for investment trusts is assets that are slow or expensive to sell: infrastructure, renewable energy, private equity, commercial property, specialist lending and some smaller-company or emerging market portfolios.

An open-ended fund must meet redemptions. If many investors want out at once, the manager has to sell assets or suspend dealing, as open-ended property funds have done on several occasions in recent years. In a trust, departing investors sell to other investors. The price adjusts instead of the portfolio, and the manager is never forced to sell a wind farm at the worst moment.

An open-ended fund promises liquidity at NAV and occasionally breaks that promise. A trust promises liquidity at whatever the market will pay, and keeps it.

The trade-off is that you may have to sell at a wide discount. When interest rates rose sharply from 2022, discounts across many infrastructure, renewable energy and property trusts widened considerably. Private asset NAVs also rely on periodic valuations, so the share price often moves before the published NAV catches up.

For mainstream large-company equities the structural advantage is smaller, and the choice comes down to manager, fees, gearing and dividend policy.

8. Costs, Stamp Duty and Holding Trusts in an ISA or SIPP

• Ongoing charge. Management fee plus running costs, as a percentage of net assets. Large trusts can be competitive; small ones often look expensive. Check for performance fees and borrowing costs, which headline figures often exclude.
• Stamp duty. As UK-listed companies, most trusts attract stamp duty reserve tax on purchases, currently 0.5%: £50 on an illustrative £10,000 purchase. It does not apply when you sell, or when you buy OEICs or ETFs. Some trusts registered outside the UK may not attract it.
• Dealing costs. Platform commission plus the bid-offer spread, which can be wide on smaller trusts. A limit order stops you paying more than you intended.

Investment trusts can be held in a stocks and shares ISA or a SIPP. Inside an ISA, dividends and gains are free of UK tax, which suits income trusts well, though stamp duty still applies on purchases. The government’s ISA guidance sets out the current rules, and our comparison of ISAs and SIPPs covers which wrapper to fill first.

9. The Main Risks

• Discount widening. Your return follows the share price, and the discount can widen just as the portfolio falls.
• Gearing. Borrowing amplifies losses, and interest is due regardless of performance.
• Key-person risk. Many trusts are closely tied to one named manager, and a departure can widen the discount quickly.
• Concentration. Specialist trusts may focus on one sector, region or asset type, sometimes with few holdings.
• Valuation risk. Private asset valuations rest on models and assumptions that may prove optimistic.
• Trading liquidity. Small trusts can be hard to trade in size.

10. A Checklist for Evaluating an Investment Trust

1. Asset fit: does the closed-ended structure suit what it owns, or would a cheaper fund do the same job?
2. Discount in context: today’s figure against its own history and its peers.
3. Discount policy: does the board have one, and has it actually used buybacks?
4. Gearing: current level, permitted maximum, and the cost and term of the debt.
5. Costs: ongoing charge, performance fee, borrowing costs and typical spread.
6. Dividend: yield, revenue cover, reserve depth and how the record was achieved.
7. Manager and board: tenure, team depth, succession planning, and independent directors who own shares.
8. Performance: NAV and share price total return over several periods, including a downturn.
9. Portfolio fit: how much it overlaps with what you already own.

11. Tracking Investment Trusts in Your Portfolio

Once you own trusts, what matters is your actual return: share price plus dividends, after stamp duty and dealing costs, which can differ markedly from the NAV return on a factsheet.

InvestInsight’s portfolio tracker helps with that side. It syncs Trading 212 through a read-only API key, or you can import buys, sells, dividends and fees manually or by CSV, logging stamp duty as a fee so the cost of buying stays visible in your history. It handles London Stock Exchange pence and pound pricing, which matters because most trusts are quoted in pence. The dividend tracker shows forecasts and yield on cost, and the analytics show allocation by sector and region and benchmark you against the S&P 500.

InvestInsight does not show NAV, discount or gearing data. For those, the Association of Investment Companies website and each trust’s factsheet are the natural sources. Other trackers such as Sharesight are worth comparing, and a spreadsheet works well for a handful of holdings.

12. Common Mistakes to Avoid

• Buying because the discount looks wide. Find out why it is wide before deciding the market is wrong.
• Paying a large premium. Premiums can vanish when sentiment turns, taking part of your return with them.
• Ignoring gearing when comparing performance. A geared trust beating an ungeared fund in a rising market may reflect borrowing, not skill.
• Treating a dividend record as a guarantee. Reserves are finite and policies can change.

Conclusion

Investment trusts are not better or worse than funds, just a different tool that earns its place in specific situations: illiquid assets an open-ended fund would struggle to hold, income strategies that benefit from reserves, and patient portfolios where a fixed pool of capital lets the manager take a long view. In return you accept a share price that can drift from asset value, gearing that cuts both ways, and stamp duty on every purchase.

Understand the discount before you buy, check the gearing and the board’s policies, and judge results by the share price return you actually receive. Approached that way, a well-chosen trust can earn a lasting place in a diversified portfolio.

Further reading

These sources cover the structure, tax treatment and live sector data in more depth.

• Association of Investment Companies
• GOV.UK: tax when you buy shares
• Investopedia: closed-end funds

This article is for general information only and does not constitute financial advice. All figures are illustrative and historical patterns are not reliable indicators of future results. Consider your own circumstances or speak to a qualified adviser before making investment decisions.