Investment Trust or Fund: Key differences explored

Investment trusts have been around for more than 150 years, but many investors today are more familiar with unit trusts and open-ended investment company (OEIC) funds. While investment trusts and OEICs share the same broad aim - pooling investors’ money to help it grow over time- there are some important structural differences that investors should understand.

Unlike OEICs, investment trusts are listed on a stock exchange, so their share price is driven by supply and demand. As a result, they may trade at a premium (above the value of their underlying portfolio) when demand is strong, or at a discount (below portfolio value) when demand weakens.

There are also important similarities. Like unit trusts and OEICs, investment trusts are collective investments: investors pool their capital to gain exposure to a portfolio of assets. They are run by a professional manager who selects investments with the aim of delivering long-term growth, income, or a combination of both. For investors, that can provide access to a diversified portfolio without having to choose individual shares.

Understanding the structure of investment trusts and OEICs

Unlike OEICs, investment trusts have a board, which is tasked with holding the investment management company to account. It aims to ensure that the investment company delivers on the objectives it sets itself, and can replace it if it doesn’t. This provides an important layer of governance for shareholders in investment trusts.

The structure means that the pool of assets is fixed. It doesn’t expand when new investors come in, or contract when investors sell out, as happens with an OEIC. This has important implications for the way the trust is run. Investment trust managers do not have to manage inflows and outflows, and therefore make decisions purely on the investment merits of individual companies . This gives them more flexibility.

Open ended funds

There are other key differences between the two structures. OEICS and others have to pay out any income from the underlying investments when it is generated. Investment trusts can reserve some of that income, and set it to one side, in order to pay out during more difficult periods. This can create a more consistent income stream for investors, which may be particularly important for investors in retirement.

Gearing

Investment trusts can borrow money to make additional investments. This is known as ‘gearing’. It lets the manager of the trust buy shares without having to sell existing investments. The risk of using gearing is that it can magnify losses at times of market difficulties, so managers need to be confident that they can generate a higher return on their investments than the cost of borrowing.

Both open and closed-ended funds have a place in a globally diversified investment portfolio. Investment trusts can bring alternative sources of diversification, income and growth for investors.