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Investment trusts vs unit trusts: What’s the difference?

Investment Trusts vs Unit Trusts

When you first make the decision to invest your money, there can be a lot of things to think about. Not only do you have to weigh up the pros and cons of different asset classes – from cash to shares – but also the types of funds themselves.

If you’ve had a look at some of the options for investing, one of the questions you might have is “What is the difference between a unit trust and an investment trust?”

While it’s easy to be put off by the names, it’s actually much more simple than you might think. Read on to find out everything you need to know about these two types of funds.

Investment Trusts vs Unit Trusts: 9 Key Differences to Consider

Investment Trusts Unit Trusts
1. Closed-ended: an investment trust has a fixed number of shares. Open-ended: a unit trust has a variable number of units.
2. The fund manager may borrow extra money to invest, called gearing. This can boost returns, but also introduces extra risk into the portfolio. Unit trusts cannot borrow capital to take advantage of investment opportunities and boost returns. However, this typically means that they are less volatile than investment trusts.
3. Shares listed on the London Stock Exchange and can be bought and sold through a stockbroker or via a fund provider platform. Units unlisted – can be bought and sold through a fund provider platform or directly through the operator of the fund.
4. Investment trusts are permitted to retain up to 15% of the income received during any financial year in a revenue reserve. Unit trusts must distribute all of the income they receive.
5. Shares in an investment trust can be bought and sold at a price that is higher (premium) or lower (discount) than net asset value (NAV). This means the value of shares is determined by supply and demand in the stock market. The price of a unit trust always reflects the value of its holdings, since it is based on the net asset value (NAV) of the underlying investments.
6. If demand for shares exceeds supply, the share price rises. If demand for units rises, the unit trust manager issues more units.
7. Performance is unaffected by asset flows, allowing the fund manager to make truly long-term investment decisions and invest in less liquid assets such as commercial property. The manager has to buy or sell assets as money flows in and out of the fund.
8. Every investment trust has an independent board of directors, responsible for safeguarding shareholder interests. An Authorised Corporate Director (ACD) is responsible for operating the fund provider in accordance with regulations.
9. Investment trusts have ongoing charges and will incur dealing fees when buying the shares. They may also have performance fees. Unit trusts also have ongoing charges and some have performance fees. They may also have initial charges, although these may be waived if investing through a platform.

Source: Schroders

What are collective investments?

When you invest, it can be tempting to micromanage the process by doing research and choosing individual investments. However, while this approach can give you a greater sense of control, it also has disadvantages.

For example, when choosing your investments, your portfolio may be overly reliant on a particular sector or asset. Furthermore, managing such a portfolio can also take up significant amounts of your time.

This is where collective investments can benefit you, as they spread your money across many different companies, sectors and regions. Typically, they either track a particular index or are overseen by a fund manager and an independent board of directors.

The main benefit of a collective fund, sometimes known as a “mutual fund”, is that it can give you a more diverse portfolio than if you chose your investments yourself. If you have too many assets in a particular sector, a market crash can have a significant effect on your wealth.

As I discussed in my blog about how to create a diversified portfolio, having a spread of assets can help protect you from exposure to undue risk. Not only can this protect your wealth, but it can also give you invaluable peace of mind.

Investment trusts and unit trusts are two distinct types of collective investments, so it’s important to know what the difference is.

What is an investment trust?

An investment trust is essentially a company that buys and holds financial assets and is typically run by a fund manager. It is a public limited company (PLC) traded on the London Stock Exchange. While they usually invest heavily in company shares, they can also buy other assets.

They are sometimes known as “closed-ended” funds since they have a fixed number of shares when they’re set up, which investors can buy and sell on the stock market.

While investment trusts usually cover the same sectors as unit trusts and “open-ended investment companies” (OEICs), they tend to have a more varied investment strategy. For example, they can hold more unusual assets such as specialist properties, private equity, and esoteric illiquid assets.

Where do investment trusts invest?

Investment trusts are often 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. These include:

  • UK Growth
  • Global Growth
  • Europe
  • Private equity
  • Property

What are the benefits of investment trusts?

Since there are a fixed number of shares, the benefit of an investment trust is that the trust managers have a fixed amount of cash at their disposal.

The fact that they don’t have to buy or sell to meet market demand means that they typically have a greater degree of stability, which the manager of an open-ended trust may lack. This allows them to have a more long-term view, which can be beneficial when seeking returns.

What are unit trusts and OEICs?

A unit trust or an OEIC (open-ended investment company) are some of the most common types of collective investment schemes in the UK.

While, in practice, they are very similar, there is a key difference when it comes to their legal structure. OEICs are set up as companies while unit trusts are set up as trusts, as the name would imply.

Both are sometimes referred to as being “open-ended”. What this means is that they are always able to accept more cash when a new investor wants to buy in, unlike with a “closed-ended” investment trust.

There are two main types of unit trust available: income and accumulation. The former pays out any income generated by the fund’s underlying assets, while the latter adds the income to the value of the unit, essentially reinvesting it for you.

What are the benefits of unit trusts and OEICs?

One of the main benefits of these types of investments is that they can have greater flexibility. If investor demand rises and more people want to buy in, they can become larger.

However, this can be a double-edged sword, as the fund will shrink when more investors sell their shares than new ones buy in.

Another benefit is that there are usually more of these funds available, giving you greater choice when investing.

Finally, investment trusts are allowed to borrow money in order to invest. This is known as “gearing” and can boost your returns.

What is gearing?

One major difference between investment trusts and unit trusts is that the former has the ability to borrow money in order to invest. This is known as “gearing” and can have a significant effect on your investments.

The amount of gearing that an investment company uses is often expressed with a rating. If it is at 100 then that means there is no borrowing, while a rating of 110 means that there is gearing of 10%. In practice, this means your gains or losses will be magnified by this amount.

For example, if you invest £1,000 into an investment trust with 10% gearing, the trust is deploying £1,100 into the stock market for you.

Provided the return the investment trust generates is greater than the interest they are paying on the borrowed money, it should be good for the trust and for shareholders – when stock markets are rising. When markets rise, the share price of a geared trust will rise faster.

Gearing has the potential to increase the returns on your investments but can also result in greater losses when there is a fall in the stock market. A trust with a high level of gearing may offer greater returns but also comes with greater risk, making an investment trust riskier and more volatile than other investments.

When markets fall, a geared trust’s shares will fall further, which can be worrying. For example, in the 2008 global financial crisis when stock markets fell sharply, some highly geared investment trusts ran into trouble.

Over a longer period – perhaps 5 or 10 years – the overall effect of moderate gearing is usually positive. It is the main reason why investment trusts have generally outperformed other types of investment funds (for example, unit trusts) that can’t gear.

While borrowing money can sometimes be a good idea, it can also be risky. If you aren’t sure if investing in a fund that uses gearing would be right for you, you may benefit from seeking professional advice.

What is “net asset value”?

If you’ve done some research on investment trusts, one of the phrases that you may have come across is the “net asset value”. This sounds complicated but is much simpler than it may seem.

Essentially, this is the value of the assets held by the trust. It is usually expressed as pence per share. So, if a particular trust holds £1 million worth of assets and has 1 million shares, then the net asset value will be 100p.

Unlike unit trusts, where the price of the units directly reflects the value of the assets held by the trust, the price of shares will be determined by supply and demand. This means that the price you pay will usually be different to the net asset value.

Is there a difference between unit trust and investment trust fees?

Typically, both open and closed-ended funds are similar in terms of cost. While many investors argue that investment trusts are cheaper, since they have lower running expenses, the fact that some of their costs are absorbed by the company makes it difficult to properly compare the two.

However, some benefits that closed-ended trusts have over their counterparts is that, since they have an independent board of directors who represent the interests of the shareholders, they can often negotiate lower charges. This can translate to a lower price for investors.

However, it’s also worth bearing in mind that since you have to buy the shares on an exchange, such as the London Stock Exchange, you may have to factor in the cost of a stockbroker’s commission.

How can the trust’s structure influence the strategy of the fund manager?

As previously mentioned, since investment trusts have a limited number of shares, they are able to make long-term decisions more easily than open-ended trusts.

Since they don’t have to accommodate for investors joining or leaving the fund, they can choose the best opportunity to buy and sell. Fund managers of open-ended funds could be forced to sell assets when their price is low or buy them when they are high, for example.

This can give closed-ended trusts a significant advantage over their open-ended counterparts.

Should I seek financial advice first?

While you may do a considerable amount of research before investing, it’s important to note that past performance is not a reliable indicator of future returns. That’s why, if you want to be able to invest with confidence, it’s important to speak to a professional.

When you work with a financial advisor, they can use their in-depth knowledge of financial services and markets to ensure that wherever you choose to invest, it’s the right decision for you.

Financial advisors can also help you to assess your financial goals and risk tolerance, enabling you to grow your wealth more effectively. Because of this, you may benefit from seeking independent financial advice before you invest, so you can do so with peace of mind.

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