How to pick the best investment trusts

Investment trusts can be quite difficult to compare for investors who are not intimately familiar with their features and workings. If you are hoping to use them in your portfolio, you need a thought-out approach to select the best ones.

The first step is no different from how you would pick an open-ended fund. You decide on a strategy for your portfolio and consider which trusts are available for each asset class and sector you are looking to gain exposure to. You then evaluate them according to all the usual suspects, such as performance against the benchmark, manager track record, underlying holdings and costs.

Laith Khalaf, head of investment analysis at AJ Bell, stresses the importance of looking at those before going into more trust-specific factors, such as the premium or discount to net asset value (NAV). “If you hold an investment trust for 10 years, the main factor that is going to drive your returns is the performance of the underlying portfolio,” he says. If the discount or premium moves in your favour, your returns will be boosted, but “the important things are the investment strategy, the investment manager and the cost,” he says.

But Rob Morgan, chief investment analyst at Charles Stanley, adds that comparing and choosing investment trusts requires some more research than picking an open-ended fund. Discounts and premiums add an extra layer of consideration. To understand whether a discount might be an opportunity, you can start by comparing it with its historical levels – a higher discount than the average could hint at a good moment to buy. The Z-score measures how far a trust’s premium or discount to net asset value (NAV) is from the one-year average. A Z-score can be considered fairly cheap when it gets below -1 and extremely cheap at or below -2.

“But looking at it versus history only tells you so much. You do have to go into the underlying reasons for the discount,” adds Morgan. These can include trust-specific issues such as high levels of expensive debt within the portfolio, or negative sentiment towards a whole asset class.

For example, discounts across the infrastructure and renewable energy sector widened in 2022 off the back of rising interest rates and their impact on asset valuations. Broadly speaking, discounts for trusts investing in unlisted assets are more complicated to assess, because the underlying valuations are based on a range of assumptions rather than on the prices of listed shares. A discount can be a hint that investors, right or wrongly, do not trust the asset valuations.

With vast sections of the investment trust world consistently trading at a discount for the past two years, discount control mechanisms have become more relevant when picking a trust. Several trusts have initiated large share buyback programmes, while others prefer deploying their cash in other ways. According to Morningstar and Winterflood data, in the first four months of 2024, the trusts that bought back the most were Scottish Mortgage (SMT), Finsbury Growth & Income (FGT) and Smithson (SSON). There is debate on how effective share buybacks are at curbing discounts, and a board’s decision not to carry out a big share buyback programme is not a sign that the trust in question makes for a bad investment per se – but it does mean the discount might take longer to narrow.

Morgan says that because investment trusts are overseen by an independent board, the management group that runs it can change over time, potentially resulting in significant changes to the trust’s strategy and performance.

This is worth checking when evaluating a trust’s track record. A relatively niche but relevant example is Schroders Capital Global Innovation (INOV), the growth capital trust once managed by Neil Woodford that was taken over by Schroders at the end of 2019. 

Finally, the size of an investment trust is also worth keeping in mind. Smaller trusts can be less liquid and have proportionally higher costs compared to larger vehicles, which can impact performance in the long term.

Read more in our 'How to use investment trusts' series

Why investment trusts are useful for investors

The trusts to buy depending on what you need    

How to pick the best investment trusts

Finding the right trusts for your portfolio

Supported by AllianzGI Investment Trusts