Are investment trusts better than funds?
19 July 2021
Question by Nick
I've been reading recently about how investment trusts are much the same as funds, but are cheaper to own. A: Is this true? and B: Do you have an article on Investment trusts on your site?
Answered by Boring Money
First off, once you start of researching this area you do find that's there's lots of lingo. So when you're reading up, you might find it helpful to take a look at our Jargon Buster down below, which helps explain some of the endless acronyms you'll come across.
To answer your second question first, yes. We do have a few articles which may be helpful for you:
Why use an investment trust?
8 things you need to know about investment trusts
As for your first question, you're right that there are quite a few similarities between investment trusts and funds.
With both, investors will have a mixed portfolio of shares, which have been hand-picked by a fund manager. Essentially the fund manager's job, is to pull together the savings of various different investors and stick them in the stock market, using the fund manager's expertise and knowledge – in theory – of which shares look like they might go up.
Some famous fund managers only offer investment trusts - such as Nick Train of the Finsbury Growth and Income Trust, James Anderson of Scottish Mortgage, and fund managers of the Ruffer Investment Company.
However, here's 10 differences between investment trusts and funds:
A key difference between investment trusts and funds, is that investment trusts are ‘closed-ended’, meaning that they have a fixed pool of capital. This makes them easier to manage, as investors buy shares on the stock market rather than by buying them from the fund manager. Meanwhile, investors buy shares/units directly from the fund manager in 'open-ended' funds. In being open-ended, these funds can experience difficulties when investors pull their money out en-masse during volatile markets, therefore the fund manager will need to take this into account. Being closed-end this situation doesn't occur for managers of investment trusts, meaning they can plan for long-term goals, thereby reducing portfolio turnover and bringing the trading costs down. Being closed-ended, managers of investment trusts do not need to worry about this situation, meaning they can plan for long-term goals, thereby reducing portfolio turnover and bringing the trading costs down.
You can invest in investment trusts for as little as £25 a month or even £50 per quarter. You can go directly to the fund managers themselves (such as Witan or Baillie Gifford or Aberdeen) to get an especially low price. Or you can go via a platform if you want all your investments in one place.
Some types of investment don’t have a lot of liquidity (i.e. there is not always a ready-buyer for them), so these more illiquid investments are better suited to an investment trust structure. Such investments include assets which cannot be quickly bought and sold such as infrastructure, wind farms, private equity or even timber. Investment trusts are therefore often a better way to manage this type of asset because the pool of money is ‘closed’. Fund managers aren't required to sell assets to meet redemptions from the fund.
They can give better returns than other collective funds. Some very clever people at CASS Business School took a look at the complex data on this, and found that investment trusts often give fund managers more freedom, which turns out to be a real advantage.
Investment trusts include extra options, such as the ability to borrow to invest, this is called leverage and can increase investment gains, but also increases risk.
Income seekers (investors who want frequent payments, to use as a supplement for traditional incomes, such as a pension) often prefer investment trusts. This is because a large number of them have a long track record of paying a high and increasing income. The AIC (Association of Investment Companies) currently lists 22 trusts which boast a year-on-year track record of dividend increases over a decade or more. For more information, see the AIC website.
On top of that, many investment trusts write a clear dividend policy into their investment aims, so investors have written guidelines for how much of the company's earnings will be paid out to shareholders.
During good years, they can reserve up to 15% of the income they receive from the investments they hold, allowing them to pay these dividends out to investors during less profitable years. This makes for a smoother income journey for investors and provide a more reliable dividend stream.
Investments trusts have a board that should look out for your interests. This board is responsible for choosing the best investment manager for the trust, and making sure that manager meets targets and keeps fees down.
Investment trusts trade on the stock exchange and operate like a normal share. Therefore their price is influenced by buyers and sellers, and the price of the investment trust does not always reflect the price of the underlying assets. When this happens, it trades above the value of the underlying shares (at a premium) and at a discount if it trades below. This means that the trust may hold £1000 of BP shares and £1000 of Vodafone shares, but it won’t necessarily trade at £2000. It may be that the trust’s price is just £1,800. This ‘discount’ to ‘net asset value’ means investors can pick up £2000-worth of assets for £1800. It does occasionally work in reverse with a fund trading at a premium.
In regards to cost:
Some investment trusts are almost as cheap as passive funds. Larger trusts can be a very cheap option. For example, the City of London Investment trust, charges an ongoing 0.4%, while the Scottish Mortgage Investment Trust (run by Baillie Gifford) charges just 0.48%.
Investment trusts are usually treated like shares and therefore most investment platforms will charge a commission of around £8-12 to buy and sell them, whereas this is often free for funds. This can make them very expensive if you plan to invest smaller amounts regularly.
Thanks to all the jargon, this is a pretty tricky topic to wrap your head around, so make sure you read around and see what other people have to say. The more you read-up the more likely you are to find an explanation which makes sense to you.
Best of luck!