Investment trusts

Investment trusts are publicly listed companies that invest in financial assets on behalf of their shareholders.

When you buy a share in an investment trust, you gain exposure to a range of assets – from quoted stocks to investments in private companies – through a single investment. This allows you to spread risk, but not eliminate it. The risk varies depending on where the trust invests.

Investment trusts are ‘closed-end’ structures, which means they raise capital only once by issuing a fixed number of shares at launch, which investors can then buy and sell on the stock market. Unlike open-ended funds, where shares are continually issued and redeemed by the fund to satisfy investors who want to buy in or sell their stake, trust managers have a fixed amount of capital to invest, and they don’t have to buy and sell assets to manage consumer demand for shares.

Investment trusts are a well-proven and effective vehicle for investing in illiquid assets and long-term growth stories. Unlike open-ended funds, which under certain circumstances may be forced to sell assets or lock investors into the fund in order to manage liquidity – or hold large cash balances on the chance that redemptions are made – the closed-end structure avoids the need for these approaches by providing liquidity to shareholders through a live price on the London Stock Exchange.

As with any company quoted on the stock market, investment trusts have to publish an annual report and audited accounts. They also have an independent Board of directors to which the manager of the trust is accountable. The Board is responsible for looking after shareholders’ interests. Their role is to ensure that the investments the trust makes are aligned with its strategy and philosophy, and that rules of governance are followed.

Net assets
Net assets provides a measure of the value of the company to shareholders and is taken from the IFRS group net assets.

Net asset value (‘NAV’)
NAV is a measure of the value of the company, i.e. its assets – principally investments made in other companies and cash held – minus any liabilities, expressed as pence per share. NAV is calculated by dividing net assets by the number of shares in issue, adjusted for shares held by the Employee Share Trust and for dilution by the exercise of outstanding share awards. NAV takes account of dividends payable on the ex-dividend date.

NAV total return (‘NAVTR’)
NAVTR is a measure of how the net asset value per share has performed over a period, considering both capital returns and dividends paid to shareholders. NAVTR is calculated as the increase in NAV between the beginning and end of the period, plus the accretion from assumed dividend reinvestment during the period. NAVTR assumes that dividends are reinvested at the NAV on the ex- dividend date.

Net revenue
Net revenue comprises income from investments less management expenses, financing costs and tax. Net revenue comprises the revenue column presented in the statement of comprehensive income and differs from total comprehensive income in excluding gains and losses on investments and other items of a capital nature. The separation of revenue and capital profits and losses is required by the AIC SORP as of fundamental importance to shareholders and other users of the financial statements of investment trust companies.

Annual dividends
Annual dividends are dividends declared as part of the company’s recurring dividend cycle and are typically paid out of earnings in a financial year. Annual dividend growth is the compound annual dividend growth rate over the period.

Dividend cover
Dividend cover is the ratio of net revenue (as defined above) to the annual dividend payable to shareholders out of profits for the year. It helps to indicate the sustainability of annual dividends.

Total shareholder return (‘TSR’)
TSR measures the return to shareholders through the movement in the share price and dividends paid during the measurement period.

Investment and pool returns
The company uses the modified Dietz method as a measure of the performance of an investment or pool over a period. This method divides the gain or loss in value plus any income, less any capital cash flows, by the average capital invested over the period of measurement.

The company also uses internal rate of return (‘IRR’), being the discount rate that makes the net present value of all cash flows from an investment equal to zero, and realisation multiples or money returns, being the cumulative returns from an investment divided by the total investment, as an indicator of the performance of individual investments on exit.

Ongoing charges
Ongoing charges represent the operational expenses of managing the portfolio in normal circumstances. Caledonia adopts the AIC methodology for calculating the ongoing charges as the annualised ongoing charges divided by the average undiluted net asset value per share in the period.

Expense items included in the ongoing charges calculation comprise recurring costs relating to the operation of the company. In addition to transaction costs and external performance fees, ongoing charges exclude share-based payment expenses, which are directly linked to investment performance, and re-measurement of defined benefit pension schemes, also linked to market movements.

Share-based payments comprise awards under the company’s performance share scheme, which vest subject to achieving NAVTR targets, as well as service requirements. Similarly, deferred bonus awards arise from annual bonus awards over 50% of basic salary, which relate to the company’s investment performance.

Premiums and discounts
Investment trusts are listed on the stock market, where market forces of supply and demand can cause the share price to differ from the net asset value, or NAV (the value of the assets held by the trust, usually expressed as pence per share). This is in contrast to open-ended funds, where the share price directly reflects the value of the assets held by the trust.

If a trust is trading at less than its NAV, it’s said to be trading at a discount. If the share price is higher than the NAV, it’s trading at a premium.

Distributable reserves
Investment trusts can retain up to 15% of income earned each year. These additional cash reserves help to maintain, and even grow, dividend payments, even in leaner years.

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