Investment trusts explained

Types of investment

Investment trusts explained

By Michael Trudeau

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Investment trusts explained

Learn all about the pros and cons of investment trusts.

Investment trusts, such as unit trusts and Oeics, allow you to pool your money with that of other investors to get exposure to a range of assets through a single investment. 

This diversity means you can spread risk by investing in tens or even hundreds of companies through one investment - but this doesn't mean there is no risk to your capital, and the risks will vary depending on where the trust invests.

Investment trusts are set up as companies and traded on the London Stock Exchange. As with any company quoted on the stock market, investment trusts have to publish an annual report and audited accounts. They also have a board of directors to which the manager of the trust is accountable. When you invest in an investment trust, you become a shareholder in that company.

Find out more: Investment trust performance - find out how investment trusts aim to produce superior returns

Open-ended vs closed-ended funds

Investment trusts have been around since the 1860s and they have long been regarded by their fans as the best kept secret of the investment world because they have traditionally had lower ongoing charges than unit trusts and therefore the potential for higher returns. This advantage has largely disappeared since January 2013, owing to changes in the way funds could charge fees.

There are important structural differences between unit trusts and investment trusts. Investment trusts are 'closed-ended' investments, meaning they issue a fixed number of shares when they are set up, which investors can then buy and sell on the stock market. 

This means investment trust managers always have a fixed amount of money at their disposal, and won't have to buy and sell to meet consumer demand for shares. This can add a degree of stability to investment trust management that a unit trust manager won't have.

By contrast, unit trusts are 'open-ended' investments and can issue or redeem units at any time to satisfy investors who want to buy into the fund or sell their stake - this may cause problems, as the manager may have to sell assets at a low point to pay investors who want to sell units.

Find out more: The Which? investment portfolios - use our unique portfolio tool to find the right mix of assets for you

Investment trust prices

The value of the assets held by an investment trust is called the net asset value (NAV), usually expressed as pence per share. If a trust has £1m worth of assets and one million shares, the NAV is 100p. However, the price of an investment trust's shares is determined by supply and demand in the stock market. This means the price you pay will almost invariably differ from the NAV.

With unit trusts, the price of the units you hold directly reflects the value of the assets held by the trust. Things aren't that simple with investment trusts. If a trust is trading at less than its NAV, it's said to be trading at a discount. If the share price is higher than the NAV, it's trading at a premium.

Often, investment trusts trade at a discount. This looks like good value, as you pay less than £100 for £100 worth of assets. However, there is no guarantee that any discount will have narrowed by the time you come to sell. If the discount widens then you'll lose out in relative terms, whatever happens to the NAV of the trust.

Less often, trusts will trade at a premium to NAV. This means you're paying more than £100 to own £100 worth of assets. You might be prepared to do this, for example, because of the skill of the fund manager. However, you need to ask yourself whether this type of out-performance is likely to last.

Where do trusts invest?

Like unit trusts, investment trusts are grouped by the geographical area and type of investment with which they are involved. The Association of Investment Companies (AIC), the trade body that represents investment trusts, lists more than 30 different sectors, ranging from UK Growth, Global Growth, Europe, Asia Pacific, Infrastructure, Property and Private Equity. 

The level of discount or premium tends to vary by sector and changes with market sentiment.

  • Last updated: February 2016
  • Updated by: Michael Trudeau