Investment trusts, like unit trusts, are collective investment funds allowing investors to spread their risks across a range of UK and foreign companies.
Both can be held in a personal equity plan to save tax and both give savers a return proportionate to their holding in the total fund. Both offer specialist funds investing in different regions or market sectors around the world, a choice of income or capital growth funds and monthly savings plans.
But although at first glance they may seem alike, investment trusts have many unique characteristics. As Ian Millward of Chase de Vere, independent financial advisers, says: "If you look at the top-performing investment trust, it will always have a better record than the top-performing unit trust. But you will also find the worst-performing investment trusts underperform unit trusts."
Unlike unit trusts, every investment trust is a company in its own right, albeit one that exists only to buy shares in other companies on behalf of its owners. As these shares are listed on the Stock Exchange, their value will change with the view of a particular trust's prospects and with the way the investment climate is shifting.
Another difference is that investment trusts can take advantage of gearing, whereby they are allowed to borrow money which they can invest in chosen stocks, something no unit trust can do. This has the effect of exaggerating both the good stock picking selections and the bad ones. With the average investment trust gearing level around 10 per cent, this makes the average trust share price more volatile than its unit trust equivalent.
When investment trust managers see a spell of market volatility, they can reduce their gearing to limit any potential damage. But as the trusts' shares are listed on the stock market, this often means that their own share prices fall in anticipation of a correction.
"As people have been talking about a market correction of some kind for months now," says Liz Walkington of Ivory & Sime, "I think you would find most trusts were fairly lowly geared. Once market sentiment turns against them, then share prices will fall."
Most trusts trade at some sort of discount. But trying to make a quick turn from buying trusts trading at above-average discounts is best left to the professionals. "Taking a five-year view, discounts are pretty irrelevant because it all comes out in the wash," says Jeremy Tigue, of Foreign & Colonial.
"Looking at a shorter period, they can make a difference. If you buy something at 5 per cent which then goes to a 15 per cent discount, while the market falls 20 per cent, then you've lost quite a lot of money."
Unlike unit trusts, investment trusts carry no initial charge in their buying price, and annual management fees are often half or three-quarters less.
One of the most important distinctions is that investment trusts have just a fixed number of shares in issue, whereas unit trusts must create or cancel units to meet buying and selling demands. This may mean that if there is a large amount of selling, the unit trust manager will have to sell off some of the fund's holdings to pay the outgoing investors. With investment trusts, the total pool of shares in the fund and its holdings remain the same.