Investment Trusts: Discounts, Gearing, Revenue Reserves, and Why They Are Different

Investment trusts are the oldest form of collective investment available in the UK — the first, Foreign & Colonial Investment Trust, was launched in 1868. Despite their long history, they remain less widely understood than their open-ended counterparts (unit trusts and OEICs). This is partly because their structural features are more complex, partly because they are not available on all platforms, and partly because they require some understanding of stock market trading that unit trust investors do not need.

Yet for investors who take the time to understand them, investment trusts offer genuine advantages: access to illiquid assets, gearing-enhanced returns, revenue reserves that smooth income, and the occasional opportunity to buy assets at a meaningful discount to their underlying value.

The Closed-End Structure: Why It Matters

The fundamental difference between an investment trust and an OEIC is that the investment trust has a fixed number of shares in issue (it is "closed-ended"), whereas an OEIC creates and redeems units daily on demand.

Implications for the manager. Because new money does not flow in and out daily, the investment trust manager is not forced to buy assets when markets are high (when new investors pile in after good performance) or sell when markets are low (when investors redeem after bad performance). This structural advantage is particularly important for managers investing in illiquid assets — private equity, infrastructure, real estate — which cannot be sold quickly without price impact. An OEIC investing in illiquid assets must maintain a liquid buffer or gate redemptions; an investment trust faces no such pressure.

Implications for the investor. The investor buys and sells shares in the investment trust on the stock exchange, just like any other share. The price is set by supply and demand — not by the underlying NAV. This creates the possibility of trading at a premium or discount to NAV, which is the most distinctive and potentially powerful feature of the investment trust structure.

Discounts and Premiums: A Two-Way Opportunity

The NAV (net asset value) per share is calculated by dividing the total value of the trust's underlying portfolio (after deducting any debt/liabilities) by the number of shares in issue.

When a trust trades at a discount: 100 shares in issue, total portfolio value £1,000,000 → NAV per share = £10. Share price = £8 → discount of 20%. The investor can buy £1 of assets for 80p.

When a trust trades at a premium: the share price exceeds NAV. This typically occurs for trusts with exceptional track records, in sectors with very strong demand (e.g., renewable infrastructure in 2020–2021), or where the trust has access to assets not otherwise available to retail investors.

Discount dynamics. The discount moves over time and varies dramatically across trusts and sectors:

• Highly rated global growth trusts (Scottish Mortgage IT) have traded at premiums and significant discounts at different points
• Smaller, less-liquid trusts often trade at persistent discounts of 15–30%
• Sector dislocations: renewable energy infrastructure trusts that traded at premiums in 2021 moved to discounts of 15–25% by 2023 as rising interest rates increased discount rates and reset NAV expectations

Discount as opportunity and risk. Buying a quality trust at a deep discount offers a potential additional return — if the discount narrows over time, you benefit beyond the underlying portfolio return. However, discounts can also widen further. A trust at a 20% discount may move to a 30% discount if the sector falls further out of favour, adding to portfolio losses.

Discount control mechanisms. Many investment trusts operate buyback programmes — repurchasing their own shares when they trade at a discount to NAV. This is NAV-accretive (buying £1 of assets for 80p) and supports the share price. Some trusts have explicit discount control policies targeting maximum discounts.

Gearing: The Amplifier

Investment trusts can borrow money to invest beyond the value of shareholders' equity. This is gearing (or leverage). UK law permits investment companies to borrow without a regulatory ceiling, though most boards operate within self-imposed limits of 10–30% net gearing.

How gearing works. A trust with £1 billion of equity and £100 million of borrowing has a gross assets of £1.1 billion and 10% gearing. If the portfolio rises 10%, the equity value rises by £110 million (10% on £1.1bn) to £1.11bn — a 11% return on the original equity.

Gearing magnifies both gains and losses. If the portfolio falls 10%, equity falls to £990m — a 10% loss on equity if ungeared, or worse with gearing depending on the level. At high gearing, equity can be substantially eroded in a severe market decline.

Types of gearing. Borrowing can be via:

• Revolving credit facilities (short-dated, flexible but variable cost)
• Debentures (long-dated, fixed coupon bonds issued by the trust itself — locks in a fixed interest cost)
• Zero-dividend preference shares (a form of structured gearing with priority over income dividends)

Structural gearing vs. tactical gearing. Some trusts maintain relatively constant gearing (structural), while others vary their borrowing actively based on the manager's market views (tactical). The effectiveness of tactical gearing as a value-add is mixed — timing markets consistently is difficult.

Revenue Reserves: Smoothing the Income Stream

Investment trusts may retain a portion of their income in a revenue reserve — distributable income that has been earned but not yet paid out. This reserve can be drawn on in future years to maintain or increase dividends when the underlying income from the portfolio is insufficient.

Why this matters for income investors. An OEIC is legally required to distribute substantially all income in the year it is earned. It cannot retain income to smooth payments. An investment trust can "bank" income in good years and draw on it in bad years.

The AIC's dividend hero list. The Association of Investment Companies (AIC) tracks investment trusts that have increased their dividends consecutively for 20 or more years. This record would be impossible for many of these trusts without revenue reserves — some of them maintained or increased dividends through the 2008 financial crisis and the 2020 COVID shock using reserves built up in prior years. Prominent examples include City of London Investment Trust (58+ consecutive years of dividend growth as at 2026 — the longest such record of any UK investment trust) and Caledonia Investments.

Revenue reserve as due diligence criterion. When evaluating an income-focused investment trust, always check the revenue reserve position. A trust paying dividends primarily from capital (disguised return of capital as income) rather than earned revenue is less sustainable. Trusts reporting revenue reserves equivalent to 1+ years of annual dividend commitments have significant cushion.

Boards and Corporate Governance

Unlike OEICs, investment trusts have independent boards of directors separate from the investment manager. This creates a governance layer that investors should be aware of:

Board responsibilities. The board sets investment policy, approves the use of gearing, monitors performance, hires and fires the investment manager, and acts in shareholders' interests. A proactive board will discount-control through buybacks, challenge the manager, and replace underperforming management.

Manager removal. Because the investment trust is a separate legal entity from the management company, the board can terminate the management contract. This has happened — Invesco's management of Perpetual Income & Growth Investment Trust (under Mark Barnett) was terminated in 2020 after prolonged underperformance, and the trust subsequently merged into Murray Income Trust (managed by Charles Luke at abrdn) later that year. For investors, manager quality and board quality are both relevant.

Key Sectors and Notable Trusts

Global equity. Scottish Mortgage Investment Trust (SMT) — Baillie Gifford, long-duration growth companies including private pre-IPO investments; F&C Investment Trust (FCIT) — one of the oldest, multi-manager global equity diversification.

UK equity income. City of London Investment Trust (CTY) — Job Curtis, yield-focused, 58+ years of dividend growth; Finsbury Growth & Income (FGV) — Nick Train, highly concentrated quality growth.

Private equity. HarbourVest Global Private Equity (HVPE) — listed vehicle investing in HarbourVest's underlying PE funds; ICG Enterprise Trust — mid-market buyout; Pantheon International (PIN) — diversified primary and secondary PE.

Infrastructure. HICL Infrastructure (HICL) — public-private partnership (PFI) assets; BBGI Global Infrastructure (BBGI) — roads, hospitals, bridges; Greencoat UK Wind (UKW) — operational UK wind farms.

Property. LondonMetric Property — logistics-focused UK REIT; Supermarket Income REIT — long-lease supermarket assets.

The AIC (Association of Investment Companies) at theaic.co.uk is the authoritative research and comparison resource for investment trusts — it provides discount/premium data, dividend history, gearing levels, and sector comparisons for all UK-listed investment companies.

Practical Considerations for Investors

Trading mechanics. Investment trusts trade on the London Stock Exchange with bid-offer spreads. For liquid trusts (Scottish Mortgage, City of London), spreads are tight. For smaller, less liquid trusts, spreads can be 0.5–1% — a transaction cost consideration if trading frequently.

Stamp Duty Reserve Tax (SDRT). Purchases of investment trust shares in the UK are subject to 0.5% SDRT (stamp duty), as with any share purchase. This is not applicable to direct OEIC purchases.

Platform availability. Some platforms restrict which investment trusts are available. Most major UK platforms (HL, AJ Bell, interactive investor) provide broad access. US-based brokerage platforms may not offer access to UK investment trusts.

Within wrappers. Investment trusts can be held within a stocks and shares ISA, SIPP, or JISA, providing the usual tax advantages. The ISA wrapper eliminates income tax on dividends and CGT on any discount narrowing gains.

Compliance Notes

Investment trust share prices can trade at significant discounts or premiums to NAV; there is no guarantee a discount will narrow. Gearing amplifies losses as well as gains and may reduce the net asset value substantially in a market decline. Dividend history and revenue reserves are not guarantees of future income distributions. Past performance is not a reliable indicator of future results. Investment trusts listed on the London Stock Exchange are subject to market risk, and values can fall as well as rise. This guide is for information purposes only and does not constitute financial advice.

How Global Investments Can Help

We review investment trust valuations, discount levels, and board quality as part of our fund selection process. For investors seeking income, illiquid asset exposure, or alternatives to open-ended funds, we can identify investment trusts appropriate for your objectives and tax position. Contact us to discuss whether closed-ended funds should form part of your portfolio.