Unit Trusts vs Investment Trusts – What are the options?

At first glance, unit trusts and investment trusts can look very similar to the novice investor. There are however a range of key differences in terms of how they are structured and how they work in operation. Here we take a look at those differences and analyse them in order to aid in the education of those individuals attempting to construct an investment portfolio which matches their specific circumstances and objectives.

Investment Trusts (ITs)

In reality Investment Trusts are public limited companies that are listed on the stock exchange which invest in shares in other companies. As such an Investment Trust consists of a diversified portfolio of shares that are professionally managed. This management is controlled by a board of Directors, subject to the Memorandum and Articles of Association.

Due to the fact that Investment ITs are ‘closed-ended’ there are a limited, fixed number of shares in issue at any one time and the price of these shares is determined by market demand.

The money raised by the IT is invested and if the underlying investments do well the share price of the investment trust rises.

Investment Trusts sometimes engage in a process known as ‘gearing’, which is the term given to the act of borrowing outside money in order to invest in more shares in an attempt at improving the IT’s performance.

If a share is trading at less than the value of its underlying assets, it’s said to be on trading at a discount. If it trades above its value, it is trading at a premium.

There are costs associated with investing in an Investment Trust. As mentioned above, the shares within an IT are bought and sold on the stock exchange and as a results investors can be charged for brokerage, stamp duty and Panel on Takeovers and Mergers (PTM) levy, a surcharge taken from investors which is charged by their brokers. An annual management charge – normally between 0.5 and 0.75% of the invested amount – will also be payable by investors.

Unit Trusts (UTs)

Just like Investment Trusts, Unit Trusts are pooled investments that are actively managed by a dedicated fund manager/management team, subject to approval by Trustees within the terms of the Trust Deed.

Instead of shares, investors purchase or sell issued units via the fund manager or fund supermarket. If demand for the units increases then the manager will issue more units for sale. The price of a unit reflects the underlying value of the shares at that particular time.

The process of gearing – where IT managers borrow money to increase investment levels – is not permissible for a Unit Trust.

UTs are subject to initial charges based upon the cost of setting up the trust and the administration of investor entry and these charges can be up to 5.5% of the invested amount. Annual management charges are also payable by investors and typically range from 1% to 1.5%.

Risk vs Reward

Arguably Investment Trusts are slightly riskier but offer the chance for greater rewards and so for those investors with a higher appetite for risk or with the objective of seeing greater returns in the shorter-term then ITs may suit their needs better. This is due to the fact that the purchasing of shares in an investment trust can be done at either a discount or premium and that ITs can engage in gearing.  The value of investments can go down as well as up and you may get back less than you invested.