Personal finance: The benefit of pooling your resources in a trust

Understanding the stock market

"When is a trust not a trust?" sounds like one of those riddles which pop out of crackers at Christmas. However, it is not supposed to be a frivolous question. The answer is: "When it is an investment trust."

An investment trust is, in fact, a limited company whose shares are quoted on the stock market. They came into being in the last century as a means of raising capital for pioneering investment overseas. Over the years their investment outlook has changed and today they concentrate on forming portfolios of shares quoted on the world's stock markets.

By comparison, unit trusts are relative newcomers. The first one was launched in 1931 to offer investors an "instant portfolio" of shares. The concept is simple. Investors' funds are pooled and divided into a number of units in proportion to their investments. The investments are held in the name of an independent trustee (hence their name).

Units in an unit trust are bought and sold by the unit trust company's managers, at a price which is extremely close to the value of the shares represented by the units. On the other hand, the price of a share in an investment trust is determined by its supply and demand on the stock market. Consequently, its price may bear little relationship to the net asset value (NAV) that it represents. Investment trust shares on average are currently selling around 15 per cent below their NAV.

There are many explanations as to why investment trusts sell at a discount. These range from the view that there is an over-supply, to the opinion that it reflects the cost of selling the portfolio. Given all the variables that determine the price of a trust's shares - supply and demand; management expertise and the view of the market in which the trust invests - it is not surprising that NAVs and prices do not coincide.

It will come as no surprise to learn that for many years a fierce battle has been raging between the proponents of unit trusts and investment trusts. The Association of Unit Trust and Investment Funds' view is that as the prices of investment trusts are determined by market forces, they are riskier than unit trusts.

On the other hand, the Association of Investment Trust Companies (AITC) emphasises that as investment trusts generally sell at a discount to the NAVs, investors obtain more shares for their money. They also point out that the charges are less than an unit trust's. Furthermore, whereas an unit-trust manager has to sell the underlying shares when unitholders want to cash in their units, an investment trust does not and, therefore, can take a longer-term investment strategy compared to an unit-trust manager.

Over the last 20 to 30 years, investment trust discounts have been in the 4 to 25 per cent range. As opposed to being a "problem" in a fundamental sense, it can, in fact, be a worthwhile advantage to investors. A smart and active investor can make money by buying at a relatively wide discount, selling when the discount has reached its narrowest for the current cycle and reinvesting in the same trust when he judges that its discount has gone as far out as it is going to go. In fact, the discount can be rather like an everlasting escalator - if you are prepared to back your judgement and to monitor your shares carefully.

If you are a long-term investor looking to build-up capital, it is well worth considering an investment trust for either a lump sum investment or regular savings plan. The golden rules are:

Do not chose a trust for its discount - make sure that you like the trust's policy, its performance and its management.

Do not sell shares just because the discount has narrowed - the change may reflect improved quality in the trust and you may do far better to hang on for an even better performance.

Look at the assets. The discount tells you how much the market undervalues the company's assets. If there is a big discount to a portfolio of good quality listed shares, you could be on to a winner - though rest assured, you are unlikely to be alone in your discovery. On the other hand, if the discount is because of the poor quality of the portfolio, the shares could seriously damage your wealth.

Finally, do not demonise the discount. Except for the minority of active investors who are looking to trade on discount movement, the trust's share price, total return and asset growth are more important.

For an introduction pack to investment trusts and performance information, telephone AITC on 0171-431 5222.

Start your day with The Independent, sign up for daily news emails
Have you tried new the Independent Digital Edition apps?
Finacial products from our partners
Property search
New Energy Secretary, Amber Rudd, wrote to the Big Six suppliers to ask whether prices are reflecting companies’ costs

It’s time to wipe out our energy debt

Companies should start to play fair and pass on reductions to customers

The programme was a look back at the Mad Men-y age of the Sixties and Seventies

Women born in 1950s facing severe financial hardship over pensions could have fates changed by Ros Altmann - should she choose to help

Women born in 1950s facing severe financial hardship over pensions could have fates changed by Ros Altmann - should she choose to help

PPI complaints were down by about a half

Banks face fresh wave of PPI compensation claims after landmark ruling

The PPI scandal has already cost Britain’s banks around £24 billion

Some experts warn that the bond sell-off may continue until the autumn, when the US Federal Reserve is expected to lift interest rates

Is it really that bad in the bond market?

The great sell-off has sparked fears for our pensions as well as bonds. Simon Read asks if you should keep calm or panic
Up and away: rates will rise but your mortgage won't escape its moorings with a long-term fix

Is a 10 year mortgage deal a fix too far?

A cut-price deal for a decade-long home loan - where's the problem? Only, says Simon Read, that circumstances can change and it won't be easy to get out
In a surprise move the Tories have decided against putting a career politician into the job. Instead they’ve handed the responsibility to campaigner Ros Altmann

New pensions minister has massive job on her hands

The Tories have appointed campaigner Ros Altmann to the post

Promises, promises: David Cameron talks to staff at Asda's head office in Leeds today

General Election 2015: How you vote next week could affect your finances

Rival party pledges could shrink your savings or grow your nest egg
Logos for the 'Big Six'; energy companies (top row from left) British Gas, EDF, RWE npower, (bottom row from left) SSE, E.ON and ScottishPower

Winter heating underpayment brings summer pain

One reader’s monthly direct debit charge has been increased by 62 per cent

Almost 15,000 people died last winter through living in cold homes that they couldn’t afford to heat

Social tenants locked into energy tariff for 40 years

Many Londoners who live in social housing estates are not allowed to switch because their landlord has ‘locked’ them in to buying from one supplier

Will your credit card rewards be scrapped following new EU rules on charges?

Providers are unhappy with new EU rules - but ultimately it is customers who will have to foot the bill
There remain more than a million unclaimed Premium Bond prizes worth collectively around £48m

Have you won £1m in the May Premium Bonds draw?

More than £60m was paid out to more than 2 million prizewinners this month

The 0 per cent introductory deals that credit cards offer are one of the most odious tricks

Beware credit card firms’ odious tricks

Why can’t we just have open and honest charges, without all the cross-subsiding?

The pound’s recent strength against the euro could be hit by economic uncertainty under a new government

How planning can make your travel cash go further

With the pound at a high against the euro, it pays to buy now before uncertainty post-election

Put the phone down on the coldcallers who see pension liberation as an opportunity to liberate your pension from you

Pension freedoms: How to deal with cold calls from scammers

Sean O'Grady offers advice on keeping your money safe
Switching to a better bank account is much easier than it used to be

More people are switching current accounts – but what do the figures mean?

Experts disagree about the 7% increase over the past year

Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Recruitment Genius: Digital Optimisation Executive - Marketing

    £30000 - £35000 per annum: Recruitment Genius: The UK's fastest growing, multi...

    Recruitment Genius: Financial Reporting Manager

    £70000 - £90000 per annum: Recruitment Genius: A Financial Reporting Manager i...

    Recruitment Genius: Payments Operations Assistant

    £23000 - £25000 per annum: Recruitment Genius: They win lots of awards for the...

    Recruitment Genius: Telephone Debt Negotiator

    £13500 - £20000 per annum: Recruitment Genius: This nationwide enforcement com...

    Day In a Page

    Sepp Blatter resignation: The beginning of Fifa's long road to reform?

    Does Blatter's departure mean Fifa will automatically clean up its act?

    Don't bet on it, says Tom Peck
    Charles Kennedy: The baby of the House who grew into a Lib Dem giant

    The baby of the House who grew into a Lib Dem giant

    Charles Kennedy was consistently a man of the centre-left, dedicated to social justice, but was also a champion of liberty and an opponent of the nanny-state, says Baroness Williams
    Syria civil war: The harrowing testament of a five-year-old victim of this endless conflict

    The harrowing testament of a five-year-old victim of Syria's endless civil war

    Sahar Qanbar lost her mother and brother as civilians and government soldiers fought side by side after being surrounded by brutal Islamist fighters. Robert Fisk visited her
    The future of songwriting: How streaming is changing everything we know about making music

    The future of songwriting

    How streaming is changing everything we know about making music
    William Shemin and Henry Johnson: Jewish and black soldiers receive World War I Medal of Honor amid claims of discrimination

    Recognition at long last

    Jewish and black soldiers who fought in WWI finally receive medals after claims of discrimination
    Beating obesity: The new pacemaker which helps over-eaters

    Beating obesity

    The new pacemaker which helps over-eaters
    9 best women's festival waterproofs

    Ready for rain: 9 best women's festival waterproofs

    These are the macs to keep your denim dry and your hair frizz-free(ish)
    Cycling World Hour Record: Nervous Sir Bradley Wiggins ready for pain as he prepares to go distance

    Wiggins worried

    Nervous Sir Bradley ready for pain as he prepares to attempt cycling's World Hour Record
    Liverpool close in on Milner signing

    Liverpool close in on Milner signing

    Reds baulk at Christian Benteke £32.5m release clause
    On your feet! Spending at least two hours a day standing reduces the risk of heart attacks, cancer and diabetes, according to new research

    On your feet!

    Spending half the day standing 'reduces risk of heart attacks and cancer'
    With scores of surgeries closing, what hope is there for the David Cameron's promise of 5,000 more GPs and a 24/7 NHS?

    The big NHS question

    Why are there so few new GPs when so many want to study medicine?
    Big knickers are back: Thongs ain't what they used to be

    Thongs ain't what they used to be

    Big knickers are back
    Thurston Moore interview

    Thurston Moore interview

    On living in London, Sonic Youth and musical memoirs
    In full bloom

    In full bloom

    Floral print womenswear
    From leading man to Elephant Man, Bradley Cooper is terrific

    From leading man to Elephant Man

    Bradley Cooper is terrific