Scottish Mortgage is one of the largest, most successful investment trusts and has stood out recently for being one of the big early investors in SpaceX, long before its IPO.

The managers of the trust also went heavily into big tech stocks like Nvidia and Taiwan Semiconductor earlier than most, and have been heavily rewarded by the AI boom over the past three years. In the past year to the end of July, it’s up around 23 per cent, compared to around 20 per cent for an All World tracker index.

Investment trusts have been a staple of the British stock market since the 19th century, with the first being the Foreign & Colonial Investment Trust, formed in 1868.

They offer distinct advantages to investors over the more widely used open-ended fund structure, or picking all your stocks yourself.

As ever, with any kind of investment there are risks and potential downsides - some of which are specific to investments trusts.

How does an investment trust work?

An investment trust is a company listed on the stock market which focuses on investing in other companies and assets, rather than manufacturing a product or providing some other service.

In fact, they are also known simply as investment companies. Another way they are referred to is closed-end investment companies.

This points to a fundamental difference with open-ended investment companies (OEICs) generally just referred to as “funds”.

Investment trusts issue shares which trade on a stock exchange and are fixed in number.

Funds (OEICs) do not issue shares - they offer units directly to investors, which are held in investment accounts. Units are issued and removed every time an investor buys into or exits a fund.

Buying shares in an investment trust is exactly the same as buying any other publicly traded shares.

Once you are up and running with an account on an investment platform, it is just a matter of searching for the trust by name and clicking through to the buy button. The platform will hold your investment trust shares for you in your ISA, SIPP or general account until you wish to sell them.

**Advantages of investment trusts **

Arguably the key advantage of investment trusts is they can offer you access to investment exposure that would be difficult or impossible to get otherwise.

This was notably demonstrated in recent times by Scottish Mortgage’s investment in SpaceX in 2018, eight years before the recent IPO.

The trust put a total of £151m into the rocket company and shortly before the IPO its stake was value at £2.98bn, an astonishing return. While an outsized example, it shows what it possible and how retail investors can gain a small stake in companies that are otherwise out of reach.

As well as access to private markets opportunities, investment trusts can offer exposure to other assets that are difficult to access directly, such as commercial real estate and commodities.

Near-instant liquidity is a big plus point too - you can make or exit your investment within seconds. In contrast, moving money in or out of a fund (OEIC) could take multiple days.

Gearing can also be considered an advantage. This means borrowing money to invest. This can increase the amount of money a trust makes for its shareholders, but also adds to the risk level.

Dividend smoothing is another benefit of investment trusts. This means trusts can hold some money back in strong performing years to top-up the amount they can pay investors in leaner years.

The net outcome is investors receive either a steady or even slightly-growing dividend each year they own shares in the trust, and will be unlikely to suddenly see the dividend they were counting on slashed.

Risk and downsides of investment trusts

A significant risk around investment trusts is the other side of the coin when it comes to being listed on the stock market.

The price of the shares is entirely determined by the buys and sells people execute. During times of market volatility or negative sentiment, shares in a trust can fall to well below the value of the assets it actually owns. This is called a discount.

A discount creates an opportunity for new investors to get in at a cheap price, but it can leave earlier buyers under water - and there’s no guarantee a discount will close, of course. Buying above the value of assets owned, the opposite of a discount, is called a premium.

Fees are a big thing to be aware of too. Having a team of fund managers and analysts running the portfolio does not come for free.

Each trust is effectively a company, with many of the costs of doing business that any other firm has. These include a marketing budget, office costs and other admin expenses.

Scottish Mortgage, for example, has an ongoing fee of around 0.33 per cent. This is competitive among actively managed open-ended funds and other trusts, but significantly more than passive funds and ETFs tracking major stock market indices like the FTSE 100 or Nasdaq. These are available for as little as 0.07 per cent.

It is possible to gain access to many of the publicly listed stocks some investment trusts and active funds hold just by owning an ETF, or buying a similar basket of stocks directly.

One other area that investors should be aware of is the possibility of activist investor intervention.

Activist investors, such as American hedge funds, have on occasion taken large positions in investment trusts and used their rights as shareholders to push for major changes in how they are run. This is not necessarily bad for the other shareholders, but it may mean an unexpected turn of events take place.

Which investment trusts have made strong returns?

There is a wide range of performance for investment trusts as you would expect, with some making investors a lot of money, some treading water and some losing money.

Just as with picking shares in other types of company, it is crucial to do your research and have a clear idea of what an investment trust’s strategy is before you put your money into it.

While good past performance certainly does not mean continued strong returns, here are three other trusts that have been among the best performers recently:

Polar Capital Technology has returned 58 per cent over the past year. It has tapped into similar trends to Scottish Mortgage by leaning heavily into the AI industry, and can be seen a viable alternative option.

Fidelity Emerging Markets has risen around 70 per cent over the past year. The trust has benefited from exposure to Asian countries and commodities exporters as the dollar has weakened and energy markets have heated up.

Biotech Growth Trust is an example of a highly specialised, focused investment trust. It has returned a remarkable 102 per cent over the past year thanks to well-picked investments in small and mid-cap biotech firms delivering handsome rewards as the sector saw a strong recovery.

Returns are correct at the time of writing but fluctuate constantly with the stock market and changing dates. Trustnet runs a tracking service for investment trusts’ performance along with information on their dividend, risk score and prices.

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.