Unit Trusts vs Investment Trusts

Posted on June 7, 2020

Unit Trusts and Investment Trusts are both forms of long-term investment vehicles. There are notable differences, and the right decision for investing money will depend on an individual’s requirements and expectations.

Unit Trusts

A Unit Trust allows individuals to buy units of a collective investment, spreading the risk across a portfolio of pooled assets. The Trust’s assets can be almost anything: property, bonds, stocks and even currency and debt are common.

Open Ended Investment

Each trust is made up of a number of units, and created as an ‘open-ended’ investment. This means that the fund manager can create new units (which will be done when an investor adds money to the Trust) and sell assets at any time. However, the total asset value of the Trust is always kept in the public domain. So is the Trust’s specified investment objective, which outlines the aims and limitations of the Trust.

Unit Trusts can give you access to a broad range of assets and their ‘open book’ policy can make this type of investment easier to understand and engage with than the denser Investment Trusts. However, as with all speculative or equity based investments, there is still an element of risk involved.

Investment Trusts

As an investment vehicle, Investment Trusts date back to the 1860s. They are also a form of collective investment although, unlike Unit Trusts, they are ‘closed ended’, meaning that there is a set number of shares in the fund from the outset. The shares are put to market in an IPO and subsequently traded on the Stock Exchange. The fund managers only have the money raised during the IPO at their disposal.

Not actually a Trust at all!

Technically the term ‘Trust’ is misleading, as these are actually listed companies and not beholden to trustees. They can hold a very diverse range of assets, including those that are not thought of as ‘liquid’ (for example commercial property or infrastructure).

As a shareholder in the company, you are entitled to vote on policy and the appointment of directors. Operating costs used to be lower than those of Unit Trusts, however in recent years the difference in price has narrowed significantly. Ongoing trading of shares need not impact funds available to the Trust managers, meaning that investment decisions may be made for the longer term.

Net Asset Value vs Market Perception

The value of assets held by any investment vehicle can vary. However an investment trust’s advertised share price will, almost always, NOT reflect the value of the assets it holds.

Let’s say a Trust has £1,000,000 in assets and one million shares. It’s ‘net asset value’ per share (or NAV for short) meaning ‘pence per share’ would be 100p. But shares can be – and usually are – both undervalued or overvalued in real terms according to supply and demand in the stock market.

When shares in a Trust are on sale for less than the NAV (the Trust is under-valued by the market) this is called trading at a discount; when they are over-valued it is trading at a premium.

Whilst Investment Trusts that are trading at a discount might look like a good investment, your investment represents a gamble that the market as a whole will recognise that fact and demand will subsequently drive up the share price.

Smoothing

When interest rates are very low, funds that generate an income are sought after. If an Investment Trust makes a profit over the course of the year, fund managers have the ability to set aside 15% of it to boost dividends in years where the Trust is not so successful. Unit Trusts or OEICs cannot do this.

Debt

The fund managers of Investment Trusts are allowed to borrow capital against share purchase, both at the IPO and at a later date (this is referred to as ‘gearing’). The leverage this gives them can bring increased profit, but it also increases the risk. If share prices fall then losses are multiplied because of the debt the fund is carrying.

Investment Trusts tend to be more popular with those who are happy to take a high risk, high-reward strategy with regards to their investment – or those who have a large portfolio and have decided to allocate a small part of it to more speculative investments.

Trusts and Risk

Whether Unit Trust or Investment Trust, at their best, both represent a way to spread risk by holding a diverse range of assets through one investment. Obviously the asset classes and markets the Trust operates in – the nature of the ultimate investment – will dictate the element of risk an investor is taking.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED. PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.

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