Investment trusts versus unit trusts
This collective approach is beneficial in many ways. For starters you have an expert managing the money on your behalf – making those crucial calls on what to buy and when to sell. Then there is the diversity and economies of scale it provides – it would require huge sums to build a portfolio of that breadth independently, and be costly to manage.
But the two types of investment vehicle should not be confused – they are both structured differently and which will suit you best will depend on your strategy and attitude to risk.
The key difference between the two is that unit trusts are open-ended and investment trusts are closed ended.
When a fund is open-ended there is no limit to the number of units available – as more people invest, more units are created.
By contrast, in a closed-ended investment trust there will only ever be a finite number of shares available, which means their price isn't just determined by their value (known as the net asset value or NAV), it is affected by supply and demand too.
If shares in the trust are in high demand, the shares will trade at a price in excess of the NAV - this is said to be trading at a premium. If the shares are not in such great demand they will trade at a price below the NAV, in which case they are said to be trading at a discount.
Another important difference is that investment trusts are companies in their own right. This means they are not bound by the same investment rules as unit trusts, giving fund managers much more flexibility.
Reliable income streams
For example, fund managers on investment trusts are able to gear - that is they are able to borrow to invest. They are also able to smooth out returns for investors by holding back up to 15% of their income in good years to bolster returns in the bad. As a result investment trusts have a fantastic track record for increasing dividend payments year after year. This can be a major boon for investors who are reliant on the income stream their trust generates.
According to the Association of Investment Companies, 12 trusts have increased dividends for more than 30 consecutive years, while the City of London Investment Trust (in the UK Equity Income sector) has increased payouts for an impressive 47 years and Alliance Trust (in the Global sector) has achieved that same feat for some 46 years.
Do investment trusts or unit trusts perform better?
This added flexibility certainly seems to provide investment trusts with the edge when it comes to returns. While there will always be exceptions, investment trusts do generally perform better than unit trusts.
Data from the AIC shows that over 10 years £100 invested in the typical investment trust would be worth £282.79, but the same figure invested in a unit trust would be worth £208.
Of course these are very general figures, but even at a sector specific level there are only a handful of occasions where unit trusts outperformed, as the table below shows.
Investment trusts versus unit trusts
|1 year||5 years||10 years|
|Sectors||Inv. Trusts||OEIC/Unit trusts||Inv. Trusts||OEIC/Unit trusts||Inv. Trusts||OEIC/Unit trusts|
|Global Growth vs. Global||120.0||119.0||171.1||155.5||275.9||206.1|
|Global Growth & Income vs. Equity Income||126.5||116.6||214.6||170.5||330.4||206.1*|
|UK Growth & Income vs. UK Equity Income||131.2||120.5||229.1||166.0||322.3||219.5|
|UK Growth vs. UK All Companies||130.2||122.4||202.6||170.6||262.9||226.4|
|Europe vs. Europe ex UK||136.5||126.9||196.9||151.4||370.8||244.5|
|AsiaPacific ex Japan||112.9||107.5||241.2||179.6||401.9||301.9|
|North American Smallers||130.9||129.4||196.1||200.3||205.9||255.3|
|Asia Pacific inc. Japan||115.3||115.2||195.2||171.4||281.1||242.5|
BLUE: Indicates investment company outperformance v OEIC / unit trust performance over given time period
RED: Indicates OEIC / unit trust outperformance v investment company performance over given time period
So which should you go for?
These performance figures suggest investment trusts win hands down – unless perhaps you're investing in North American Smaller Companies – but that doesn't mean you should move all your money out of funds and into an equivalent trust.
Investment trusts have a very different risk profile to unit trusts. Both their ability to gear and their pricing structure increases their risk. So, while borrowing can enhance returns in rising markets, the downside is that it will magnify losses when markets fall. And when investment trusts lose money, not only will their NAV fall, but the share price will take an additional hit if a lack of demand for the shares causes the discount to widen.
So investors in trusts need to be prepared for more volatility, particularly in the short term. As returns show, this shouldn't be a major problem for long-term investors who have the time to ride out these peaks and troughs, nonetheless it is an additional risk that investors need to take into account.
For investment trust ideas check out the Moneywise Investment Trust Awards 2013
A collective investment vehicle (known in the US as a “mutual” or “pooled” fund) and similar to an Oeic and investment trust in that it manages financial securities on behalf of small investors who, by investing, pool their resources giving combined benefits of diversification and economies of scale. Investors buy “units” in the fund that have a proportional exposure to all the assets in the fund, and are bought and sold from the fund manager. The price of units is determined by the value of the assets in the fund and will rise or fall in line with the value of those assets. Like Oeics (but unlike investment trusts) unit trusts and are “open ended” funds, meaning that the size of each fund can vary according to supply and demand of the units form investors. Unit trusts have two prices; the higher “offer” price you pay to invest and the “bid” price, which is the lower price you receive when you sell. The difference between the two prices is commonly known as the bid/offer spread.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.