As the old saying goes, ‘Look after the pennies and the pounds will look after themselves.’ It seems that now more than ever we are being urged to put money aside for the future. And despite recent reverses, history suggests that the best way to generate wealth over the longer term is to invest in a broadly spread portfolio of shares.

This, of course, is exactly what investment trusts do. Investment trusts are companies that invest in the shares of other companies. Basically, they pool investors’ money and a fund manager then invests in the shares of a wider range of companies than is possible for a single investor.

For those seeking to build their investment portfolio over time, most investment trust shares are now available through savings schemes, which were introduced more than 20 years ago as a simple way for investors to buy shares in these companies without the need to use a stockbroker.

A successful revolution
‘The first savings scheme launch was revolutionary,’ says Annabel Brodie-Smith, Communications Director at the Association of Investment Companies (AIC). ‘For the first time, private investors could buy investment trust shares direct, at a low cost and with greater flexibility. Today, they are a popular way for private investors to purchase investment trusts.’

The first investment trust savings scheme was introduced in 1984 by Foreign & Colonial Investment Trust, the oldest of these vehicles, having been originally launched in 1868 with a portfolio made up mainly of overseas government bonds and some cattle and railway companies.

The scope of investment trust portfolios have broadened considerably since then, but the main attractions of an investment trust saving scheme have always been cost effectiveness and simplicity. By buying a few shares, investors can gain access to a professionally managed portfolio investing anywhere in the world that the manager feels offers an attractive opportunity.

Sherry-Ann Sweeting, marketing manager at The Scottish Investment Trust, explains, ‘The extensive range of investment trusts available, with varying levels of risk and potential reward, provides enormous choice. Some investment trusts are more specialised, investing in one country – such as the UK or the US – or in specific market sectors – such as technology or commodities. Others invest for income and/or capital growth.’

She adds, ‘As well as providing a worldwide spread of investment risk and opportunity, global growth investment trusts tend to be among the most cost effective of collective vehicles, having very low management charges, with total expense ratios (TERs) generally less than one per cent.’

Raising the profile
Investment trusts are often neglected by investors either because they are not aware of them or they don’t know enough about how they work. James Budden, managing director of Witan Investment Services, argues, ‘A big reason why more open-ended funds are sold is that they are distributed through independent financial advisers, who tend to recommend them because they get commission. They don’t get commission on investment trusts because of the different way they are structured.’

However, investment trust saving schemes are arguably one of the most cost-effective methods for investing in investment companies. A key attraction is that you can buy shares either by depositing one-off lump sums or through making regular contributions to build your investment over time. The costs are kept to a minimum because the investment trust company will usually use its own broker to buy parcels of shares on a regular basis on behalf of its savings scheme investors, thereby taking advantage of lower institutional dealing rates.

Minimum monthly payments start from as little as £30 for some saving schemes and you can make lump-sum investments of up to £250 (see table, page 18). As Annabel Brodie-Smith points out, ‘Whether you are saving for your children, looking to supplement your retirement income or simply putting some money aside for a rainy day, savings schemes are an ideal way to access investment trusts, and they can be extremely good value.’

Building up your investment
Most schemes allow investors to use any dividends they receive to buy more shares in their chosen investment trust. If you are a regular saver, the dividend will usually be
held and added to your next monthly contribution, while if you are a lump-sum investor, the payments will be reinvested when they have reached a suitable amount, although the longer it is held the more money you will miss out on as interest isn’t paid on the amount in limbo.

Arguably, one of the advantages of regular saving is pound-cost averaging. Buying shares on a monthly basis means the highs and lows of the share price are spread out over time. When prices are high, you buy less and when the price falls, you buy more.
Apart from creating a form of investor discipline, this method means that the average purchase price will be lower than the market price over any given period. The use of pound-cost averaging has allowed investors to benefit from the recent market volatility simply because they were buying more of their chosen investment when the price was low.

‘Collective investments should be an integral part of all investment strategies and plans. Through their ability to be widely diversified, encompassing varieties of asset classes, investors are able to gain exposure to markets and sectors, which would otherwise be off limits, because of minimum investment levels and costs,’ argues Andy Parsons, advice team manager at The Share Centre.

Investment trusts can also borrow money to invest – a term commonly referred to as ‘gearing’ (see page 21). This improves the performance of a trust when its investments are doing well. However, if it doesn’t perform as well as expected, gearing will also magnify this underperformance.

The basic idea of gearing is to make enough of a return on the investments purchased with the borrowed money to cover the cost of the loan and make a profit. There are some trusts that don’t use gearing at all, and others tend to only borrow small amounts.

Brodie-Smith says, ‘Gearing, or borrowing, allows investment companies to take advantage of a long-term view of a sector or to take advantage of a favourable situation or a particularly attractive stock without having to sell existing investments. The purpose of gearing is to magnify the company’s performance: if a company “gears up” and the markets rise, and the returns outstrip the costs of borrowing, the overall returns to investors will be even greater. But if markets fall and the performance of assets in the portfolio is poor, the losses suffered by the investor will similarly be magnified.’

She points out, ‘It is important to remember that, historically, markets have risen. Over the long term, the performance of investment companies has benefited from gearing. The level of gearing does vary from sector to sector and trust to trust and not all investment companies gear. The average gearing for AIC conventional investment company members at the end of January was 13 per cent.’

Saving for the future
Saving for children is a key investment concern and, while children can’t hold shares in their own right, you can designate them as beneficiaries of share investments by setting up a bare trust to be passed on to the child when they reach the age of 18.

Many saving schemes now run products branded specifically for saving on behalf of children. For example, Witan’s Jump Investment Trust allows you to invest £25 a month or lump sums of £100.

Witan’s Budden comments, ‘As a nation, we appear to be placing greater emphasis on saving for the future needs of our young ones. Regardless of the way the funds are ultimately used, the seed suggesting long-term saving is a good thing is being planted, and the youth of tomorrow are being encouraged to think about and plan their own financial future.’