Megan is a senior researcher and writer at Which?, with a background in data analysis and stats in the public and charity sectors.
Investment trusts allow you to pool your money with that of other investors to get exposure to a range of assets through a single investment, in the same way as investment funds and ETFs.
They are set up as companies and traded on the London Stock Exchange. When you invest in an investment trust, you become a shareholder in that company.
Investment trusts are 'closed-ended' investments, meaning they issue fixed number of shares when they're set up, which investors can 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 mutual fund manager doesn't have.
Please note: the content contained in this article is for information purposes only and does not constitute financial or investment advice.
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.
When you invest in an investment fund, the price you pay to invest reflects the NAV.
But with investment trusts, the price you pay will almost invariably differ from the NAV as the price of shares is determined by supply and demand in the stock market instead.
If a trust is trading at less than its NAV, it's said to be trading at a discount. If it's higher than its 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.
Like funds, 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, for example global growth or private equity.
The level of discount or premium tends to vary by sector and changes with market sentiment.
Where and in what a trust invests will partly determine how risky it is. You can also invest in ethical investment trusts.
Our money guidance team can’t tell you what to invest in – but they can explain how to get started and make your own well-informed decisions. Unlimited access to them via phone is included in the Which? Money subscription.
Find out moreInvestment trusts don't necessarily perform better than open-ended funds, though they often have in the past.
When investment trusts do out-perform their open-ended rivals, it can sometimes be explained by a combination of lower costs (although that advantage has narrowed in the last few years), the closed-ended structure of the trust and the effect of 'gearing'. This means investment trusts can borrow money to invest, which can have a dramatic effect on the value of your investments.
When stock markets are rising, gearing is useful because it magnifies any gains you make. But when markets are falling, gearing will increase your losses.
This means the more borrowing a trust has, the greater the capital risk you face, but you also have the potential for higher returns. The combined effect of gearing and the discount means investment trusts are likely to be more volatile than equivalent funds.
This means if you invest in investment trusts you should be prepared for a rockier road with bigger ups and downs.
The Association of Investment Companies (AIC) publishes details of each trust's gearing policy – a gearing rating of 100 means the trust has no borrowing, a rating of 110 means your gains or losses will be magnified by 10%, etc. – in other words, the trust has gearing of 10% of total assets.
Potentially, if you prioritise reliable dividends over the long-term, as opposed to spikes and troughs.
Investment trusts can hold back up to 15% of dividends each year to allocate to a 'revenue reserve'. This means they can hold back when pay-outs are high to keep income steadier when the dividends dry up.
Some trusts are dubbed 'dividend heroes' for consistently increasing their dividends over 10 or 20 years. Though, an increase may not necessarily mean the income paid out is high – only that it's higher than it was previously.
Other trusts are more aimed at growing the overall value of your investment than paying you an income. It depends on your overall investment goals which strategy would be better for you.
Investment trusts are actively managed, so they tend to have higher ongoing charges than tracker and index funds.
Trusts may have similar costs to actively-managed open-ended funds, though trusts enjoy some advantages.
Trusts have less admin to pay for because they don't have to deal with money coming in and out and have independent boards of directors representing the interests of shareholders – as such they will often negotiate lower annual charges as trusts grow.
They also have a notable disadvantage: trusts are treated by investment platforms in a similar way to shares. This means you'll likely have to pay one-off fees when you buy and sell trusts, even if fund trading is free.
You'll have to pay stamp duty of 0.5% when you invest in an investment trust, even with an Isa. If you place an order with a paper form, purchases of less than £1,000 are exempt from stamp duty.
There are a few things you should consider when choosing an investment trust:
In the end, there is no definitive answer to whether investment trusts or open-ended funds are better. The former have advantages, particularly when you want exposure to more illiquid assets, but they're not guaranteed to outperform, and they may be more volatile over short-term periods.