Investment trusts and unit trusts – ten big differences

29th April 2014

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Hargreaves Lansdown has put out a comparison of investment trusts versus unit trusts to mark the launch of its new investment trust research website. The site is available at www.hl.co.uk/shares/investment-trusts

Danny Cox, Head of Financial Planning, Hargreaves Lansdown says: “Investment trusts and unit trusts are both tools in the investor’s armoury, but there are some key differences which savers should be aware of when deciding where to invest. Happily both investment trusts and unit trusts attract their fair share of talented managers, indeed some well-known names run both types of fund.”

Ten differences between investment trusts and unit trusts

1.              Closed-ended rather than open-ended

Investment trusts are ‘closed-ended’ investments, usually with a fixed number of shares in issue. This effectively means investment trust managers have a fixed pool of money to invest, unlike unit trusts which create or cancel units depending on demand, depending upon whether money is flowing into or out of the fund.

2.              Premiums/discounts

A consequence of being ‘closed-ended’ is that the price of an investment trust is driven by supply and demand. If a trust is popular with investors, its price can be driven higher than its Net Asset Value (NAV) – the value of the underlying investments. This is known as trading at a premium. Conversely if supply exceeds demand the price can be driven lower than the NAV – known as trading at a discount. This is in contrast to unit trusts and OEICs, whose price is solely dictated by the NAV.

3.             Pricing

Shares in investment trusts are traded on the London Stock Exchange and the price will vary throughout the trading day. Unit trusts/ OEICS are valued once a day, in most cases at 12.00 noon.

4.             Exposure to areas not covered by unit trusts

The closed-ended structure makes it easier for investment trusts to focus on less well-known and niche areas, where investments can be harder to buy and sell in large quantities. Examples include trusts which invest in private equity, property, or more obscure stock markets such as those in developing countries.

5.              Gearing

Investment trust managers have the flexibility to borrow money in order to purchase investments – this is referred to as ‘gearing’. If the total assets of a trust are worth £100 million, and the manager borrows £10 million, this is expressed as 110% gearing. This can enhance returns if the manager makes the right decisions, but magnify losses if the opposite were true. The increased risk plus the cost of borrowing the money need to be factored in.

6.              Performance

In a rising market, as we have seen over the past five years, gearing can help generate superior returns for investment trusts compared to unit trusts as the manager has more capital invested in the stock market. However, during 2008’s crisis, heavily geared investment trusts suffered significantly higher losses than comparable unit trusts, which do not use gearing.

7.             Smoothed dividends

Investment trust managers can hold back up to 15% of the income generated by the underlying investments each year. This creates a cash reserve which can be used to boost dividends in tougher times. Trusts which use this facility therefore often have more consistent dividend records – in some cases delivering many consecutive years of dividend growth for their investors.

8.              Choice

There are approximately 400 investment trusts compared to around 2,500 unit trusts/ OEICS.

9.              Charges

Investment trusts and unit trusts carry similar charging structures, but investment trusts are more likely to have performance fees.

10.              Information

Knowing a fund or trust’s underlying holdings is a key factor when analysing and deciding whether to invest. This information is usually widely available from unit trusts and some larger investment trusts, however is not always readily available from smaller trusts.

HL has also listed the 5 most popular investment trusts held on the HL Vantage Platform

Fidelity China Special Situations PLC

Edinburgh Investment Trust plc

Scottish Mortgage Investment Trust

City Of London Investment Trust

Perpetual Income & Growth Investment Trust

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