Investing Basics: Investment trusts vs Unit Trusts and OEICs

Investment trusts, unit trusts and open ended investment companies (OEICs) are types of actively managed collective investment funds that the DIY investor may consider for their portfolio – writes Christian Leeming

There are a few key differences in terms of the way they are structured which means that they may behave differently in certain circumstances.

Unit trusts are known as ‘open-ended funds’ on the basis that they grow or contract in line with demand – issuing or cancelling units in the fund.

Investment trusts are ‘closed-ended funds’ because they raise a set amount of cash and issue a set number of shares; for there to be a buyer in an investment trust there has to be a seller.

Each investment trust has a board of directors and is listed as an investment company on the London Stock Exchange; their shares are traded just like any listed company.

When researching any fund, its past performance is a key factor to consider; investment trusts can be shown to outperform unit trusts in most sectors over periods of ten years or more, whereas over periods shorter than five, investment trusts are less likely to prevail.

‘over time investment trusts have outperformed unit trusts and OEICs’

Because of the way in which they operate, investment trusts may experience greater volatility in their share price which some may find uncomfortable, but over time investment trusts have outperformed unit trusts and OEICs.

Why Investment Trusts Outperform

One factor is that investment trusts can take a long term view without having to sell stock to pay out those exiting the fund or buy expensive stock when markets are bullish which is the case for open ended funds; investors tend to leave a fund when markets are faring badly which means that the fund sells assets cheaply and takes longer to bounce back.

This means that investment trusts can invest in assets that may be harder to sell quickly, like property and infrastructure, but which may yield greater returns; unit trusts have to stick to more easily sold assets, like shares and even then may have to sell its prized assets if there is a rush for the exit.

Another key point of difference, and factor in favour of investment trusts, is that, unlike unit trusts, they can accrue up to 15% of the income received in any one year to underwrite dividends in leaner times; even after the global financial crisis, many investment trusts managed to continue to increase their dividends year on year and some have done so for decades.

A further difference, is that investment trusts are allowed to borrow money against their reserves in order to achieve amplified or ‘geared’ exposure to investments; this could deliver enhanced returns if the fund manager gets it right, but can equally increase losses if the market or a particular investment goes the wrong way.

It is gearing that delivers the superior performance of investment trusts over time, but the peaks and troughs along the way are likely to be more pronounced than those of a unit trust; for investors seeking income and stability over a long time horizon, investment trusts may be the answer