Investment trusts versus unit trusts

25 February 2014

This collective approach is beneficial in many ways. For starters you have an expert managing the money on your behalf – making those crucial calls on what to buy and when to sell. Then there is the diversity and economies of scale it provides – it would require huge sums to build a portfolio of that breadth independently, and be costly to manage.

But the two types of investment vehicle should not be confused – they are both structured differently and which will suit you best will depend on your strategy and attitude to risk.

The key difference between the two is that unit trusts are open-ended and investment trusts are closed ended.

When a fund is open-ended there is no limit to the number of units available – as more people invest, more units are created.

By contrast, in a closed-ended investment trust there will only ever be a finite number of shares available, which means their price isn't just determined by their value (known as the net asset value or NAV), it is affected by supply and demand too.

If shares in the trust are in high demand, the shares will trade at a price in excess of the NAV - this is said to be trading at a premium. If the shares are not in such great demand they will trade at a price below the NAV, in which case they are said to be trading at a discount.

Another important difference is that investment trusts are companies in their own right. This means they are not bound by the same investment rules as unit trusts, giving fund managers much more flexibility.

Reliable income streams

For example, fund managers on investment trusts are able to gear - that is they are able to borrow to invest. They are also able to smooth out returns for investors by holding back up to 15% of their income in good years to bolster returns in the bad. As a result investment trusts have a fantastic track record for increasing dividend payments year after year. This can be a major boon for investors who are reliant on the income stream their trust generates.

According to the Association of Investment Companies, 12 trusts have increased dividends for more than 30 consecutive years, while the City of London Investment Trust (in the UK Equity Income sector) has increased payouts for an impressive 47 years and Alliance Trust (in the Global sector) has achieved that same feat for some 46 years.

Do investment trusts or unit trusts perform better?

This added flexibility certainly seems to provide investment trusts with the edge when it comes to returns. While there will always be exceptions, investment trusts do generally perform better than unit trusts.

Data from the AIC shows that over 10 years £100 invested in the typical investment trust would be worth £282.79, but the same figure invested in a unit trust would be worth £208.

Of course these are very general figures, but even at a sector specific level there are only a handful of occasions where unit trusts outperformed, as the table below shows.

Investment trusts versus unit trusts

  1 year 5 years 10 years
Sectors Inv. Trusts OEIC/Unit trusts Inv. Trusts OEIC/Unit trusts Inv. Trusts OEIC/Unit trusts
Global Growth vs. Global 120.0 119.0 171.1 155.5 275.9 206.1
Global Growth & Income vs. Equity Income 126.5 116.6 214.6 170.5 330.4 206.1*
UK Growth & Income vs. UK Equity Income 131.2 120.5 229.1 166.0 322.3 219.5
UK Growth vs. UK All Companies 130.2 122.4 202.6 170.6 262.9 226.4
North American 112.2 120.6 183.5 175.6 212.1 188.3
Europe vs. Europe ex UK 136.5 126.9 196.9 151.4 370.8 244.5
Global Emerging 111.7 101.0 137.3 154.0 390.0 325.6
AsiaPacific ex Japan 112.9 107.5 241.2 179.6 401.9 301.9
Japan 161.2 132.6 219.7 150.5 206.9


Property 123.9 106.7 168.8 112.7 167.6 154.0
UK SmallCap 145.9 130.7 254.9 211.1 374.9 289.9
Japanese SmallCap 149.8 139.7 215.4 213.6 170.1 183.3
TMT 130.4 117.6 268.5 214.6 506.9 225.2
European SmallCap 145.4 129.0 203.5 187.6 362.3 353.3
North American Smallers 130.9 129.4 196.1 200.3 205.9 255.3
Asia Pacific inc. Japan 115.3 115.2 195.2 171.4 281.1 242.5

BLUE: Indicates investment company outperformance v OEIC / unit trust performance over given time period

RED: Indicates OEIC / unit trust outperformance v investment company performance over given time period

So which should you go for?

These performance figures suggest investment trusts win hands down – unless perhaps you're investing in North American Smaller Companies – but that doesn't mean you should move all your money out of funds and into an equivalent trust.

Investment trusts have a very different risk profile to unit trusts. Both their ability to gear and their pricing structure increases their risk. So, while borrowing can enhance returns in rising markets, the downside is that it will magnify losses when markets fall. And when investment trusts lose money, not only will their NAV fall, but the share price will take an additional hit if a lack of demand for the shares causes the discount to widen.

So investors in trusts need to be prepared for more volatility, particularly in the short term. As returns show, this shouldn't be a major problem for long-term investors who have the time to ride out these peaks and troughs, nonetheless it is an additional risk that investors need to take into account.

For investment trust ideas check out the Moneywise Investment Trust Awards 2013

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