What do you want from an investment trust?

When you buy into an investment trust, you can either aim for a nice, steady income or chase growth.

Which you pick will depend on your objectives and attitude to risk. Here, we look at both strategies and point out the issues you need to be mindful of.

Investing for income

Armies of income-starved investors have turned to investment trusts in recent years to help shore up their incomes. And many have been rewarded for their decision.

Figures from the Association of Investment Companies (AIC), the trade body for investment trusts, show that 29 investment companies have increased their dividends consecutively for the past 10 years.

They can achieve this because investment trusts have more flexibility with dividends compared to some of their peers.

Annabel Brodie-Smith, spokesperson for the AIC, explains: "Investment companies, unlike some open-ended counterparts (such as unit trusts), have a structural advantage because they are able to squirrel away some of the income they receive each year into their revenue reserves to help boost dividends in more difficult years.

"This is known as 'dividend smoothing' and means many investment companies are able to continue to pay and boost dividends through both the good times and the bad," she says.

But while investors in the dividend-paying trusts have benefited, their popularity has had an impact on the value of the shares, making them expensive for new investors to buy.

Brodie-Smith adds: "In terms of income versus growth and their popularity - the discount/premium figures say it all. There has been an insatiable thirst for income in this low-interest-rate environment and if you look at the income sectors, lots of them are on premiums versus their growth equivalents.

Five things to consider when picking an investment trust1. Avoid high fees. Look for a high-quality trust with ongoing charges of no more than 1%, preferably less. Some trusts also charge performance fees if they meet a given performance target. Steer clear of these where possible.2. Watch out for gearing (when trusts borrow money to invest). It has the effect of magnifying gains in a rising market, but also magnifying losses when markets fall. It will also eat into your returns, so avoid highly geared trusts.3. Look at the manager's track record, which you can find on websites such as morningstar.co.uk. You want a manager who consistently delivers strong performance, not a one-year wonder.4.Check whether the manager has a personal stake in their fund. Those who do have all the more reason to invest wisely.5.Look at the discount or premium. Ideally, you're looking for a trust with a good track record and a highly regarded manager who just happens to be on a wider than usual discount that's likely to narrow again over coming months. You might have to pay a premium if you want an income-producing trust

"For example, UK Growth & Income is at a 1% premium, UK Growth is on a discount of 10%, Global Growth & Income is on a premium of 5%, whereas Global Growth is on a discount of 8%."

However, she warns: "Investors need to consider whether they are happy to buy a company on a premium in return for the income. They also need to think about their time horizon - investment companies are for the long term, 10 years or longer."

Income-focus not appreciated

Tim Cockerill, investment director of investment manager Rowan Dartington, says the income story is sometimes not fully appreciated.

"With an income strategy, the manager is focusing on stocks that generate a healthy dividend, which will grow over time. If they get this right, then the share price is likely to rise too," he says.

"The growth in dividends is often overlooked but is a key component of the return for many investors - frequently, the yearly increase in the dividend will outstrip inflation too.

"Stocks paying good levels of dividends can be found across the market-cap range but there is a bias towards large-cap stocks, so income funds can often have common holdings," he adds.

He points to the City of London investment trust, which has increased its dividend each year for the past 46 years and is currently yielding 3.9%.

"It's not a trust to set the world alight but it's an excellent long-term holding for investors looking for income. It is on a 3% premium at present."

Cockerill adds: "Schroder Oriental Income is another trust with a very experienced manager - Matthew Dobbs - and is yielding 3.2%.

"The benefit of this trust is the investor has exposure to the high-growth regions of Asia, so longer term the potential for growth is very good. It can, however, be volatile and this should be considered."

In a perfect world, investors would buy into an investment trust at a discount and sell when the discount has narrowed or turned into a premium.

Cockerill says: "With equity markets having picked up this year, discounts have narrowed and some trusts are trading on premiums and large ones in some cases - as a general rule, I like to avoid paying any premium but for a quality trust up to 5% is OK to pay.

"However, it is important to realise premiums can disappear and discounts open up, which will mean the price of the trust has fallen faster than the prices of the underlying stocks. For long-term investors this isn't something to get too concerned about but to be aware of. As always with investments, think long term and buy quality."

Brodie-Smith also offers some tips for the income hunter. She says: "If you are looking at an income company [investment trust with a strategy for income or one that offers income shares that only deliver an income to investors], you need to look at the dividend yield - these are the annual dividends expressed as a percentage of the share price. And how often that dividend is paid as an increasing number of investment trusts are paying quarterly dividends.

"Check the dividend history - does it increase dividends consistently? Are dividends growing rapidly or not (the five-year dividend growth figure will tell you this)? Is the income being paid from capital (a few companies do this) or is it from income (the majority do this)?"

Growth investing

Investment trusts offer investors focusing on building their capital an easy and cost-effective way to get equity exposure and the opportunities for growth can come from just about any market in the world.

Cockerill says: "This means you could invest for growth in the UK or somewhere more exotic, such as India - or both, of course. However, the risk associated with each trust and especially those in the emerging markets, such as India, are very different.

However, he adds: "All investment trusts have full-time managers with substantial resources, experience and skills behind them and it is this that you pay an annual management fee for."

My preference is for managers with long time horizons as I think this has proved the better strategy for making money."Tim Cockerill

A key advantage is that managers do not have to manage the cashflows of investors buying and selling their trust - this is done through a stockbroker - so they can concentrate on the job at hand, hopefully to the investor's advantage.

Growth strategies centre on finding stocks the manager thinks will grow in value over time. "Small and mid-sized stocks tend to deliver higher rates of growth than large companies, so growth strategies often target this type of company," explains Cockerill.

He says that styles of management vary, as does the focus of the investment process. For example, investment time horizons also vary with some managers taking a longer-term view than others and this changes the character of the trust.

"My preference is for managers with long time horizons as I think this has proved the better strategy for making money.

"A key factor with growth strategies is the manager is not seeking out an income return; they will, however, receive some dividends but it is not part of their strategy to focus on them, and any which are received will be reinvested into the portfolio."

He points to Henderson Opportunities as a good example of a UK growth trust. Cockerill says: "It is unconstrained, which means it can select any size or type of stock in the UK market, is managed by James Henderson who has many years of experience in this area and a good record. It is on a discount of 15% at present, which is attractive."

He also picks out Monks, a Global Growth trust managed by Baillie Gifford, for praise.

It offers broad and diversified exposure to global equity markets and is on a 12% discount. He also likes the Templeton Emerging Markets investment trust, which has long been the favourite of many investors looking to invest in this region.

"The lead manager, Mark Mobius, has been a leading light in this sector for more years than most," he explains, adding: "At present, this trust has been having a difficult time because growth in the global emerging markets has slowed but, longer term, the reasons for investing remain sound and buying now may well prove to be good timing. The discount is 9%."