Page 7: Understanding risk
There are many specialist Investment Trusts which invest only in one sector. For example, you can invest in a trust which buys shares only in pharmaceutical companies or hi-tech industries. Other examples include trusts which buy shares only in financial institutions or communications companies.
Because these Investment Trusts focus on specific fields they are not spreading their risks. They are therefore considered to be medium to high risk.
Investors putting their money into Investment Trusts need to understand the level of risk they are taking. Big risks can deliver high returns but can also lead to significant losses. For example, the financial press became excited about the prospects of new technology shares, particularly those associated with the Internet. Many investors saw this as a chance of making lots of money quickly. However, for many companies in this sector the bubble soon burst. This was because the cost of promoting a new company to the public is very high and the length of time required for them to take-off is years, rather than months. This caused serious cash flow problems for several 'star' companies. Share prices, which had risen at high speed, came crashing back to earth with a bump.
Because the fund managers of major Investment Trusts have a good understanding of risk, many of them were able to anticipate the risk involved in investing too heavily in new technology companies. So at a time when the shares of well established companies were falling as a result of all the hype associated with the so called 'new economy', wise and experienced fund managers were also investing in strong companies in the 'old economy'. Experienced Investment Trust managers have a very good idea of the risk associated with particular investments and, unlike short-term speculators, they often take a long-term view in order to protect their investors.