Investing Basics: Investing in Investment Trusts and Unit Trusts

The DIY investor looking for a potentially higher return than from a unit trust or OEIC, willing to take a little more risk may and happy to tie up their money for at least five years may consider investment trusts.

Unlike unit trusts, investment trusts trade freely on the stock exchange and there is therefore immediacy and transparency in the bid and the offer prices.

Unit trusts are priced once a day with the unit prices set at the net asset value (NAV) of the fund divided by the number of units; by contrast shares in investment trusts are priced by the market.

Regular valuations allow a would-be investor to calculate whether or not an investment trust is ‘undervalued’ – i.e. the price of each share is less than the value of all assets held in the company divided by the number of shares.

Just because a company appears undervalued by this metric, there is nothing to say that the investment trust will trade any closer to NAV in the future; the market may be down valuing a stock for a reason, but it may offer the opportunity for an investor prepared to take the risk a chance to profit.

‘undervalued investment trusts may offer the opportunity for an investor prepared to take the risk a chance to profit’

If the investor picks a winner the investment trust may move closer to NAV and there may be uplift in the share price as well as the price of the underlying assets held by the trust.

A contrary viewpoint may suggest that the difference between its share price and its NAV introduces a degree of complexity to owning investment trusts; if you buy an investment trust at a premium and sell at a discount, you would do worse than someone who invests in an equivalent unit trust.

Those seeking income in recent years have chased returns from investment trusts and as a result the most popular investment trusts traded at substantial premiums, making them less attractive to those looking to buy in.

However, recent figures from the Association of Investment Companies suggest that there are now some heavily discounted stocks to choose from where, for example, in the equity income sector twenty one of the twenty five trusts trade at an average discount of 3%.

Bargain hunters should look at the objective of the fund they are considering, look at its holdings, and in particular the track record of the manager; do they have a record of beating the market, how much risk do they take and what is their investing style.

A good indicator is how the current discount or premium compares to a longer-term average.

Product Costs and Platform Charges

Investment trusts and unit trusts are similar in terms of cost; investment trusts may appear cheaper because of their lower running expenses, but this may be difficult to quantify from the company accounts.

Annual management charges for both investment trusts and unit trusts range from 0.5% to 1% and vary on a product by product basis; specialist trusts such as those targeting property or emerging markets may be more expensive.

Some investment trusts may also charge performance fees that are payable when the trust beats a particular benchmark.

Unit trusts also charge an initial fee which is a one-off payment to buy into a fund and this can be as high as 5% when the fund is purchased directly from the issuer; however, most online brokers and fund platforms will offer a significant discount to this and may levy no initial fee.

Platforms typically charge less in platform and dealing fees for investment trusts as opposed to unit trusts

There will also be trading and custody costs associated with the investment platform, or online broker you choose which may vary greatly from one to another.

Platforms typically charge less in platform and dealing fees for investment trusts as opposed to unit trusts.

Unit trusts and OEICs are charged a percentage of the holding which is either uncapped or capped at a very high level; in contrast investment trusts may be charged a flat fee, no fee, or a percentage fee with a lower cap.

However, whilst many platforms do not charge you to buy or sell unit trusts, all platforms charge you to deal in investment trusts.

Bid-offer spread

Traditionally, unit trusts were ‘dual priced’ which means that each day a price was calculated to purchase units (the ‘bid’) or redeem them (the ‘offer’); however most unit trusts have now adopted the structure of open ended investment companies (OEICs), which means they have just a single price for buying or selling.

Investment trusts trade with a bid-offer spread which represents the broker’s profit on the transaction.