Investment trust

An investment trust is a company with a set number of shares. Unlike an open-ended investment fund, an investment trust is closed ended. This means there are a set number of shares available, which will remain the same no matter how many investors there are. This can have an impact on the price of the shares and the level of risk of the investment trust. Open-ended investment funds create and cancel units depending on the number of investors.

The price of the investment trust shares depends on two main factors:

• the value of the underlying investments (which works in the same way as open-ended investment funds); and
• the popularity of the investment trust shares in the market

Closed-ended funds
This second point applies to investment trusts but not to open-ended investment funds or life assurance investments. The reason is because they are closed-ended funds. The laws of economics say that if there is a high demand for something, but limited supply, then the price goes up. So, if you own some investment trust shares and there are lots of people queuing up to buy them, then you can sell them for more money. On the other hand, if nobody seems to want them, then you will have to drop the price until someone is prepared to buy.

The result is that investment trust shares do not simply reflect the value of the underlying investments: they also reflect their popularity in the market. The value of the investment trust’s underlying investments is called the ‘net asset value’ (NAV). If the share price is exactly in line with the underlying investments, then it is called ‘trading at par’. If the price is higher because the shares are popular, then it is called ‘trading at a premium’, and if lower, ‘trading at a discount’. This feature may make them more volatile than other pooled investments (assuming the same underlying investments).

Improving performance
There is another difference that applies to investment trusts: they can borrow money to invest. This is called ‘gearing’. Gearing improves an investment trust’s performance when its investments are doing well. On the other hand, if its investments do not do as well as expected, gearing lowers performance.

Not all investment trusts are geared, and deciding whether to borrow and when to borrow is a judgement the investment manager makes. An investment trust that is geared is a higher-risk investment than one that is not geared (assuming the same underlying investments).

Split-capital investment trusts 
A split-capital investment trust (split) is a type of investment trust that sells different sorts of shares to investors depending on whether they are looking for capital growth or income. Splits run for a fixed term. The shares will have varying levels of risk, as some investors will be ahead of others in the queue for money when the trust comes to the end of its term.

The tax position is largely the same as for open-ended investment funds. You should be aware that tax legislation changes constantly and you should find out the most current position.

With-profits funds

Stock market return linked but with fewer ups and downs than investing directly in shares

If you save regularly or invest a lump sum using a life insurance policy, you might choose to invest in a with-profits fund. These aim to give you a return linked to the stock market but with fewer ups and downs than investing directly in shares. However, they are complex and are not as popular a form of investing as they used to be.

The money you invest is pooled together with money from other people and invested in the insurance company’s with-profits fund. The fund is managed by a professional investment manager, who puts the fund’s money into different types of investment, such as shares, property, bonds and cash.

Annual bonuses 
The costs of running the insurance company’s business are deducted from the fund, and what is left over (the profit) is available to be paid to the with-profits investors. You receive your share of profits in the form of annual bonuses added to your policy.

The company usually tries to avoid big changes in the size of the bonuses from one year to the next. It does this by holding back some of the profits from good years to boost the profits in bad years – this process is called ‘smoothing’.

Terminal bonus
You might also receive a ‘terminal bonus’ when your policy matures. You can ask the insurance company to give you details about its bonus policy before you buy. With most policies, the amount of profit you earn depends mainly on the performance of the investments in the with-profits fund. Usually, once added, bonuses can’t be taken away.

But the insurance company can claw back some or all of the bonuses paid by making a Market Value Reduction (MVR) – or Market Value Adjustment (MVA) – to your policy if you surrender early. This is most likely in times of adverse investment conditions like a stock market crash.

Types of with-profits fund

Conventional with-profits funds
An initial sum assured (guaranteed minimum sum) is increased by the addition of annual bonuses and a terminal bonus. The size of bonuses depends on fund performance, the costs of the insurance business, and the need to smooth bonuses between good and poor years.

The trend has been for bonus rates to fall as the result of difficult market conditions. Although market value reductions can be applied, this would not normally be the case. Instead, surrender penalties would usually apply if the policy was terminated early with no reductions applied on maturity.

Unitised with-profits funds
A unitised fund is split into units – when you pay into it, you buy a certain number of units at the current price. Unit prices increase in line with bonuses declared and do not fall. Or if additional units have been added, these are not taken away (but market value reductions can be applied).

There might be surrender penalties if you decide to take your cash early. Bonuses are handled differently depending on the type of unitised with-profit fund you have.

A fixed price unit never changes, so bonuses are paid as extra units to your policy, as opposed to a variable price where bonuses are given as an increase in the unit price, so each unit you hold is worth more.

Bonuses

There are two kinds of bonus:
Annual bonuses, also called ‘regular’ or ‘revisionary’ bonuses
Final bonus, also called the ‘terminal bonus’

Policy terms
Once the bonus has been added, an annual bonus can’t be taken away – even if the fund performs poorly in future – as long as you continue to meet the terms of your policy. A final bonus might be added at the end of your policy. Whether you receive one and how big it is depends on how well the fund does.

In good years, the fund manager can choose to keep some of the profits to help cover losses in bad years. This means that if there are long stretches without a profit, you might get low annual and final bonuses – or even no bonuses at all.

Market Value Reduction 
The insurance company can make a Market Value Reduction to your policy if you surrender early, or in times of adverse investment conditions like a stock market correction.

If you leave a policy early, this reduction might claw back a large part – or even all – of any bonuses that have previously been added.

Inherited estate 
A fund needs to keep enough money on hand to meet its expenses, run the business and to pay what it owes to policyholders.
But over time, some funds build up far more than they need – usually through profits that were held back to cover losses that never happened. This extra value is called the inherited estate. The insurance company can use the extra money in one of two ways – for a distribution or a re-attribution.

Distribution – handing out extra funds
Each year, insurance companies must look at their inherited estate to see if they have more than they need to keep the fund running. If they have too much, they can choose – or in some cases be required – to pay out the extra to policyholders – this is called a distribution.

A distribution can be paid out over time or as a one-off payment. The company can use the extra money to either give you a cash payout or increase the value of your policy Distributions are not guaranteed – you won’t necessarily receive a distribution even if you hold the policy to the end.

Reattribution –using extra funds to restructure
In rare cases, an insurance company might use the extra funds from the inherited estate to change the structure of the fund. For example, if a different structure would make the fund cheaper to manage. If the company does this, you’ll get compensation for the part of the inherited estate you’re giving up to the insurance company. This is normally a one-off cash payment.

If your with-profits fund goes through reattribution, your insurer must write to you with information on:

Reattribution process – including dates and a summary of who is involved
Reattribution proposals – what the insurance company wants you to give up and what benefits and compensation you’ll get in return
Policyholder advocate’s views – the policyholder advocate negotiates on your behalf with the company – they will write to you about whether the firm’s proposals are in your best interest.

Stocks & Shares ISAs

Investing in a wide range of different tax-efficient investments

From July 2014, Individual Savings Accounts (ISAs) can now be used to hold stocks and shares or cash, or any combination of these, up to the current annual limit. An ISA is a ‘wrapper’ that can be used to help save you tax.

A Stocks & Shares ISA is a wrapper that can be put around a wide range of different investment products to help save you tax.

A number of different types of investment can be held in an ISA, including:

Unit trusts
OEICs (Open-Ended Investment Companies)
Investment trusts
Exchange traded funds
Corporate and government bonds
Individual stocks and shares

Whole allowance 
You can pay a total of £20,000 a year into an ISA in the current 2017/18 tax year. The whole allowance of £20,000 can be paid into a Stocks & Shares ISA, a Cash ISA, or a combination of these.

Your yearly ISA allowance expires at the end of the tax year, and any unused allowance will be lost. It can’t be rolled over to the following year. You can choose between making a lump sum investment and/or making regular or ad hoc contributions throughout the tax year.

Investment value
Any increase in value of the investments in your Stocks & Shares ISA is free of Capital Gains Tax, and most income is tax-efficient.

You can only pay into one Stocks & Shares ISA in each tax year, but you can open a new ISA with a different provider each year if you want to. You don’t have to use the same provider for your Cash ISA if you have one.

ISA rules on deceased spouse ISA transfers
ISA rules introduced in April 2015 now permit the surviving partner of a spouse or registered civil partner who died on or after 3 December 2014 to receive an additional ISA allowance equal to the value of the deceased’s ISA savings at the time of death.

Transferring ISAs
Should you wish to switch your current or previous year’s ISA to a different provider’s ISA while simultaneously keeping future tax benefits intact, you have to arrange for a transfer rather than selling and reinvesting.

All ISA providers have to allow transfers out, but they don’t have to allow transfers in. You can transfer money from a Cash ISA to a Stocks & Shares ISA.

If you transfer an ISA that you have paid into during the current tax year to a new provider, you must transfer the whole balance. For ISAs from previous years, you can choose how much to transfer.

For most of the investments you would put into a Stocks & Shares ISA, the value can go can go down as well as up, and you might get back less than you invested. The level of risk in your Stocks & Shares ISA will depend on the investments you choose to put into it.