Where to start in the stock market as a new investor? There are lots of options – thousands and thousands in fact. That can be confusing. One approach I think investors new and old alike should consider is buying shares in an investment trust.
What is an investment trust, exactly?
Basically it is a pooled fund. So the company has money it uses to buy shares in other companies. It then sells shares in itself, which investors can buy. Its own price can move up and down independently of its portfolio valuation. So sometimes such trusts sell at a discount (or premium) to a sum-of-the-parts valuation of their portfolio.
I reckon there can be some good reasons to buy into investment trusts – but also some watchouts. Of course, like any investment, some trusts do far better (or worse) than others.
My points below relate to investment trusts in general, not a specific one (though I use one to illustrate some points).
Easy diversification
A key principle of risk management is avoiding concentrating too much risk in one place. That sounds simple – and it is. But diversification is no less powerful or important for that.
As investment trusts typically buy into dozens or sometimes even hundreds of companies, they offer a straightforward form of diversification.
Expert managers – sometimes
Some trusts track an index or use some other automated trading strategy. Others employ managers – often at great expense – to choose shares to buy (this is the difference between what are known as passive and active approaches).
Consider Scottish Mortgage Investment Trust (LSE: SMT) as an example.
Its share price is down 38% in the past three years or so. Over five years, though, it is up 60%. That is more than 10 times the average share price growth seen in FTSE 100 firms in that period.
The explanation for both the three-year fall and five-year gain is the same: Scottish Mortgage’s fund managers have focused mostly on growth shares, including Nvidia and Tesla.
So the trust’s fortunes have to some extent reflected those of leading growth shares, due to the investment choices its managers have made. Managers can help an investment trust perform much better than the market overall – or much worse.
Access to unlisted companies
Another interesting thing about Scottish Mortgage is its dividend history. It last cut its dividend after the Wall Street Crash – close to a century ago!
But as with any share, past performance is not necessarily a guide to what may happen in future.
Anyway, if I wanted to buy a share with a long dividend track record I have a number of shares I could choose from.
However, if as a small private investor I wanted to buy a share in an unlisted growth company like SpaceX I could not. Guess what, though? SpaceX is Scottish Mortgage’s third-biggest holding, accounting for over 5% of its value.
An option to consider
Investment trusts can have other downsides to the ones I mentioned above, not least fees and costs.
Still, I see a lot to like about them in principle. That is why, when looking for shares to buy, they are on my radar, although I decide on a case to case basis whether a given investment trust is suitable for me.
