The principle is straightforward: if a lot of people put their money together and invest as a group, they can buy a wide range of shares and spread the risk. This form of investment is extremely popular.
There is more than pounds 138bn invested in unit trusts, the UK's most popular form of pooled investment. But their much older cousins, the investment trusts, have attracted pounds 48bn and offer an attractive alternative.
An investment trust is a company that has its shares traded on the Stock Exchange. Instead of making hair spray or running airlines, investment trusts buy shares in other companies. Their profits come from the dividends paid on the shares they own and the gains they make from buying and selling shares.
Every investment trust has to publish an annual report and accounts that will spell out its investment strategy. That might involve aiming to generate income, specialising in a particular industry or focusing on a geographical area. The aim of the trust is usually found in its name; no prize for guessing what the Ivory Sime UK Smaller Companies trust invests in.
The best-performing trusts have done well for investors. According to Chase de Vere, the financial advisers, pounds 1,000 invested in the top-performing Murray Enterprise trust five years ago would now be worth pounds 4,621.72. That, of course, is no guarantee of what might happen in future.
Up to pounds 6,000 of an investment in most trusts can be placed in a personal equity plan, which means that any dividends or capital gains are tax-free. If the trust has more than 50 per cent of its assets invested outside the European Union, only pounds 1,500 can be sheltered in a PEP.
Many investment trusts also offer regular savings scheme, so you do not always need a lump sum to start.
By comparison with unit trusts, investment trusts have the advantage that they can put money into a wider spread of investments. These include companies whose shares are not publicly traded, property and even commodities. The charges levied by investment trusts are also generally lower.
Despite this, investment trusts are only suitable for more experienced investors, according to Graham Hooper of Chase de Vere. This is because investment trusts are complicated by the fact that their shares often trade at a discount to the value of their assets.
Shares in investment trusts are traded on the open market so their value is determined by supply and demand. The value of the underlying investments might stay the same or even increase, but the value of your shares will fall if few other people want to buy them off you. That could happen if, for example, the sector in which your trust invests becomes unpopular.
Discounts can be either totally irrelevant or vitally important. It all depends on whether the discount has narrowed or widened since you invested. The problem is uncertainty; you never know how much you will get until you sell. That puts a lot of people off.
Split-capital trusts are even more complicated, although they are becoming popular. These are specialised trusts that issue different classes of shares to attract different sorts of investors.
A split-capital trust has a finite life: when it is launched there is a specified date in the future when it will be wound up. On that day all of the value in the trust is distributed to the shareholders. But different groups of shareholders get a different slice.
Zero-dividend shares are particularly popular. These pay no dividends through the life of the trust but hand back a pre-set amount when the trust is wound up. This is called the redemption value. There is no guarantee that you will be paid the agreed amount, just that you and other zero- dividend shareholders will be paid first.
These are a few of the options, but be sure to take proper advice.
q The Association of Investment Trust Companies (0171 588 5347) produces a series of fact sheets for people interested in investment trusts and split capital trusts.Reuse content