How do investment trusts differ from unit trusts?

Collective investments such as unit trusts and investment trusts can spread your investment – and risk – across dozens of different companies. Rob Morgan looks at the major differences between them.

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  1. Rob Morgan

Some investors are highly active and enjoy researching and choosing their own individual shares, bonds and other investments. However, this “hands-on” approach can have disadvantages. For instance, it can be difficult to obtain sufficient diversification without incurring high transaction costs, and it could be a challenge to devote enough time to monitoring this kind of portfolio.

This is where collective investments such as unit trusts and investment trusts can offer a convenient solution. These spread your investment – and risk – across dozens of different companies and are either managed by a professional fund manager or designed to simply track a particular index.

There are some important differences between unit trusts and investment trusts, and knowing these can help you make an informed choice about which is best for you.

Unit Trusts and OEICs

Unit trusts and OEICs (Open Ended Investment Companies) are the most common way of pooling investors’ money to provide exposure to a portfolio of assets. The difference between unit trusts and OEICs is in their legal structure - unit trusts are established as trusts whereas OEICs are incorporated as companies, though in practice they are very similar.

Both unit trusts and OEICs are “open ended”, meaning the number of units or shares in issue expands or contracts according to investor demand: The more people invest the bigger the fund gets. The price of each unit fluctuates based on the value of the underlying assets and is usually calculated and announced on a daily basis.

There are two main types of unit: income and accumulation, often abbreviated to “inc” and “acc”. Income units pay out any income generated by the underlying assets whereas accumulation units add this income to the value of the unit, effectively reinvesting that income for you.

There are thousands of unit trusts and OEICS from numerous fund providers with each one falling into one of around 30 sectors, which defines the areas in which they can invest.

Investment Trusts

Unlike unit trusts and OEICs, investment trusts are “closed ended” funds, which means there are a certain number of shares in them. Therefore the price is dictated by supply and demand rather than a calculation of the underlying asset values, though over time the price tends broadly track movements in the value of the portfolio.  It means, however, that shares can trade at a “premium” or a “discount” to their inherent value, an added risk or, potentially, an opportunity to buy in at an attractive price in the case of a share trading at a discount.

Another key difference is that investment trusts are incorporated as companies and traded on a stock exchange – so like any individual share there is continuous pricing during market hours and you pay stock broking fees when buying and selling.

Many investment trusts have the ability to borrow to invest, which most unit trusts and OEICs don’t. This can magnify investment returns but it can also result in greater falls when markets go down. This coupled with the impact of supply and demand on the share price means investment trusts are typically more volatile (have bigger ups and downs) than an equivalent unit trust or OEIC.

Investment trusts cover broadly the same sectors as unit trusts and OEICs, but there is often more variation in terms of objectives and investment strategy.  For instance, they are more likely to cover more esoteric areas and assets that are difficult to buy and sell such as specialist property, private equity or “frontier” markets like Africa. A closed-ended structure for these areas is generally preferable as otherwise demand for units would mean the regular buying or selling of underlying assets, which could be unrealistic or difficult to achieve at a desirable price.

Choosing collective investments

There are thousands of collective funds available so it can be difficult to know where to start. Our Foundation Fundlist can help as a starting point for your research. It represents our preferred investments across the major sectors; active funds where we have conviction that the manager is likely to outperform over the long term as well as some passive fund or “trackers”. In addition our Foundation Portfolios blend a handful of Foundation Fundlist funds into ready-made portfolios for a variety of investment objectives.

This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in collectives should only be made after reading the Key Investor Information Document, Supplemental Information Document and/or Prospectus. If you are unsure of the suitability of your investment please seek professional advice.
 

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