Pooled stocks and shares are a sensible choice - and investment trusts offer special advantages
INVESTMENT TRUSTS have been around for more than a century. The Foreign & Colonial Investment Trust, launched in 1868 as the world's first collective investment vehicle, raised pounds 1m to invest in government stocks of foreign countries and colonial territories. The prospectus said it aimed "to give the investor of moderate means the same advantages as the large capitalist... spreading the investment over a number of different stocks".

The principle of investment trusts is still the same. Like unit trusts and open-ended investment companies, they are pooled funds of stocks and shares from a wide range of issuers. But investment trusts are incorporated as quoted companies, and instead of buying a unit in a fund, investors buy shares in the company.

"Although [investment trusts] have been around for aeons, they've not been commonly used," says Fiona Price, an independent financial adviser. "They can be more volatile than unit trusts because of the discounts and premiums, which slightly complicates things."

Because they are closed-ended funds with a fixed amount of capital, no one can buy shares in an investment trust unless someone else is willing to sell. Therefore the share price fluctuates according to supply and demand, rather than reflecting the value of the underlying investments. So investment trusts often trade at either a discount or a premium to their net asset value (NAV).

At the moment, shares in such trusts are trading at an average discount of 14 per cent to their NAV, according to the Association of Investment Trust Companies. Some trusts specialising in the Far East are trading at a 44 per cent discount.

Gavin Haynes, investment officer at the IFAs Whitechurch Securities in Bristol, says this is one of the attractions. You hope to buy shares in a trust at a discount and increase your returns when the shares rise.

At least, that is the theory, he cautions. Investment trusts often appear attractive because of the discount to NAV, but rather than shrinking, as bargain-hunters hope, that discount may widen. Investment trusts that have performed badly have often been those previously trading at large discounts. Investment trusts can also be "geared" - borrowing money in order to invest. "Some gear themselves up to 20 per cent, so, effectively, they are investing 120 per cent of your money," says Mr Haynes. Though this may be good when there are lots of buying opportunities, it can exaggerate losses when times get tough.

The trusts have no restrictions on how they invest, unlike unit trusts. They can hold property as an investment, and also buy shares in unlisted companies. This is riskier, but gives fund managers more scope, which can mean higher returns.

Split capital investment trusts are a type of specialised investment trust that can be useful, for example, for school fees planning.

It is the low-risk, zero-dividend preference shares that tend to be used to invest for school fees. These shares pay no dividend, but are instead entitled to a fixed but relatively conservative return when the trust is wound up, and have first call on the trust's money.

But most commonly this type of trust holds capital and income shares. Capital shares, usually last in the pecking order, are much more risky than zeros, but stand to make higher returns if the trust does well. Income shares pay income from the dividends of all the shares held, but none of the capital growth.

Mr Haynes recommends Henderson Investors for their wide range of trusts, including The Bankers, a general international fund, and the specialist Strata, investing internationally in smaller companies. Fidelity is good for European and UK investment trusts.

Charges on investment trusts can be lower than those made on unit trusts, says Gavin Haynes. "On most occasions you can buy them direct through the group. They often take a small percentage as a dealing fee and most offer savings plans." With a savings plan you can often save as little as pounds 25 a month.

Fiona Price & Partners: 0171-430 0366; Whitechurch Securities: 0117 9442266; Association of Investment Trust Companies: 0171-431 5222

Investment Trusts

n Are closed-end investment funds, incorporated as public companies.

n Have no investment restrictions.

n Can borrow money to invest.

n Can be held tax-free as a PEP, subject to restrictions.

n More volatile than unit trusts.

n Usually have lower charges than unit trusts.

n Issue shares which often trade at a discount or premium to the value of their assets.

n Shares can be bought directly from the trust or through a stockbroker.