Investment trust or unit trust – more than a simple open or shut case?
This article illustrates the important differences between investment trusts and unit trusts, and is designed to help investors make the investment decision which is right for them.
30 March 2016
Choosing the funds in which to invest hard-earned cash is an important and complex decision.
Not only do investors need to choose between funds that invest in different countries, sectors and asset classes, there are funds that are structured differently too. Among the two most commonly debated are closed and open ended funds - that is, investment trusts and unit trusts.
They are both pooled investment funds run by a professional manager who picks and chooses a portfolio of assets on behalf of investors – these might include company shares, bonds, or property. Often, a fund manager may run both types of funds with similar aims and almost identical portfolios.
While they might look the same, behind the scenes there are some crucial differences. Where your favourite manager runs a closed and open ended fund - which should you choose?
Investment trusts are effectively companies that hold assets such as shares. They are run by a fund manager and is backed by an independent board acting in the best interests of shareholders. The company itself is listed on the London Stock Exchange. While investment trusts predominantly invest in the shares of other companies, they can also invest in other financial assets.
As a closed ended fund, investment trusts have a fixed number of shares in an issue. This allows managers to take a longer-term view because they do not have to sell assets when investors sell their shares.
Investment trusts suit a number of different types of investors thanks to some of the unique features that set them aside from other types of funds.
Income seekers will be interested to know that investment trusts can hold back up to 15% of income generated by underlying assets each year to build up a reserve to be used to smooth dividend payments in tougher times. This means investors can enjoy a steady income, however markets are performing. In certain circumstances, investment company boards may elect to pay income out of capital. While this can erode the long-term capital returns generated by the funds, many investors are happy to prioritise short-term income payments.
Growth investors might be interested in another unusual feature which allows investment trusts to borrow. This means that if managers think there is value in a particular market, they can borrow money to use for further investments. This is known as “gearing”.
In a rising market, returns from an investment trust can be magnified because gearing means managers are better able to take advantage of rising share prices. However, when share prices fall, the losses of geared funds can be exaggerated.
Investment trusts can allow investors to gainexposure to some specialist sectors which are difficult for them to access through open-ended funds. More specialist investment trust options include funds that buy illiquid assets, such as infrastructure and private equity, where open-ended funds' fluctuating size makes investment much less practical.
The pricing of investment trusts works in a unique way too. When the price is greater than the value of the assets held in the company, this is known as a premium. At a time it is less, it is known as a discount.
Unit trusts are the most common types of collective investment scheme in the UK and are also referred to as open-ended funds, because they will always accept more cash from investors – they just become bigger to accommodate the demand. On the flip side, if there are more sellers than buyers, the fund will become smaller. This is because it is structured as a company, that can create shares for new investors and which will buy shares back from an investor if they wish to sell.
The price of a fund always reflects the value of its holdings. When more investors want to buy into the fund than sell, the manager issues more units. When the opposite is true, the manager cancels units.
They are more widely used even though some are more expensive than their investment trust alternatives. It’s important to compare costs.
The great advantages of open-ended funds are their flexibility to make more units, as well as the fact there are far more funds available, offering a much greater choice for investors.
There is no one-size-fits-all answer when it comes to investing because everyone’s circumstances and attitudes to risk are completely different. The right approach to building a portfolio is to be balanced and considered – sometimes the right instruments will be a unit trust, sometimes an investment trust. Unit trusts are by far the most popular route to investing. Yet investment trusts can be more suitable in some cases. Investors do not necessarily have to choose between them anyway - many hold a mixture of the two. The most important thing is not the type of vehicle, but the manager’s ability to outperform the market.
Arming yourself with the facts is a must, and if in doubt, seek independent financial advice. If you are thinking about making a new investment or changing your investment strategy, speak to your Financial Adviser. If you do not currently have a Financial Adviser, you can find one near you at www.unbiased.co.uk
Please remember that the value of investments and the income from them may go down as well as up and you may not get back the amounts originally invested.
Schroders offers a range of investment trusts and unit trusts covering a wide range of regions and asset classes.
To find out more, please visit www.schroders.co.uk
- Investment Trusts
Important Information: The views and opinions contained herein are those of Schroders’ Investment team, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. UK: Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA, is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. Further information about Schroders can be found at www.schroders.com US: Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc, a SEC registered investment adviser and is registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan providing asset management products and services to clients in Canada. 875 Third Avenue, New York, NY, 10022, (212) 641-3800. www.schroders.com/us