When it comes to investing, the world is full of options. Among the most common investment vehicles are investment trusts and funds. As someone who has spent considerable time exploring the intricacies of different investment types, I often get asked: “Are investment trusts better than funds?” It’s a reasonable question, and one that deserves a thoughtful and detailed answer. In this article, I’ll break down the pros and cons of each, offer comparisons, and give you some clear insights into which might be the better choice for your portfolio.
Table of Contents
What are Investment Trusts and Funds?
Before diving into comparisons, let’s first define what we mean by “investment trusts” and “funds.”
Investment Trusts: An investment trust is a type of company that pools together money from investors to invest in a range of assets such as stocks, bonds, or real estate. They’re listed on a stock exchange, meaning they can be bought and sold like regular stocks. The key feature of investment trusts is that they are closed-ended, meaning the number of shares available is fixed. If you want to buy shares, you have to purchase them from another investor rather than from the trust itself.
Funds: In the world of investing, “funds” is a broad term that includes different types of pooled investments. The most common types are mutual funds and exchange-traded funds (ETFs). Unlike investment trusts, funds are open-ended, meaning that more shares can be created if demand increases. They are typically managed by a fund manager, who oversees the investments on behalf of all the investors.
Now that we know the basics, let’s explore whether investment trusts are better than funds by looking at some key factors.
1. Liquidity
Liquidity refers to how easily you can buy or sell an investment. The more liquid an asset is, the quicker and easier it is to convert it into cash without significantly affecting its price.
Investment Trusts: As investment trusts are traded on stock exchanges, they offer high liquidity. You can buy or sell shares at any time during market hours, just like regular stocks. However, the liquidity can be affected by factors like market conditions and investor sentiment. Since the number of shares is fixed, it’s possible that demand for the shares might fluctuate, causing the price to move either higher or lower than the net asset value (NAV).
Funds: Funds, especially mutual funds, are typically less liquid than investment trusts. When you buy or sell shares of a fund, the transaction doesn’t happen in real-time. Instead, your buy or sell order is executed at the end of the trading day, based on the fund’s NAV. However, ETFs, which are a type of fund, are traded on exchanges like stocks and therefore offer more liquidity similar to investment trusts.
Comparison Table: Liquidity
| Feature | Investment Trusts | Funds |
|---|---|---|
| Liquidity | High, traded on stock exchanges | Varies (ETFs: High, Mutual Funds: Low) |
| Trading Hours | During market hours | End of the trading day (for Mutual Funds) |
| Buy/Sell Process | Can buy/sell at any time, subject to market demand | Buy/sell orders executed at NAV |
2. Fees
Fees can eat into your investment returns, so it’s essential to understand what you’ll be paying when investing in either trusts or funds.
Investment Trusts: Generally speaking, investment trusts tend to have lower fees than actively managed mutual funds. However, they do have a fixed annual management fee, which is usually higher than that of passive ETFs. The fees for investment trusts are typically listed as a percentage of the assets under management (AUM). Moreover, because they are listed on stock exchanges, they may also be subject to buying and selling commissions, depending on the broker you use.
Funds: Funds can vary widely in terms of fees. Actively managed mutual funds tend to have higher management fees due to the involvement of a fund manager who actively selects investments. On the other hand, passively managed funds, such as index funds and ETFs, generally have lower fees since they simply track an index or follow a predetermined strategy.
Comparison Table: Fees
| Feature | Investment Trusts | Funds |
|---|---|---|
| Annual Fees | Moderate to High (depending on the trust) | Varies (Actively Managed Funds: High, ETFs: Low) |
| Transaction Costs | Brokerage fees may apply | Transaction fees (if any) may apply |
| Management Fees | Fixed annual fee, often lower than active funds | Active Funds: High, Passive Funds: Low |
3. Performance and Returns
The performance of an investment is one of the most important factors when deciding between an investment trust and a fund.
Investment Trusts: Because investment trusts are closed-ended, their share price can trade at a premium or a discount to the underlying net asset value (NAV). This creates an opportunity for investors to buy shares at a discount, which could lead to higher returns if the trust’s value increases. However, there is also the risk that the price could trade at a discount for extended periods.
Funds: Funds tend to trade at or near their NAV because of their open-ended structure. However, actively managed funds may generate higher returns due to professional management and market expertise. Passively managed funds, while generally providing more modest returns, often outperform actively managed funds in the long term due to lower fees and a more straightforward investment strategy.
Example Calculation:
Let’s say you invest £1,000 in an investment trust with a NAV of £100 per share, and the shares are trading at a 10% discount to NAV.
| Investment | NAV per Share | Discount/Premium | Share Price | Amount Invested | Shares Purchased |
|---|---|---|---|---|---|
| Investment Trust | £100 | -10% (Discount) | £90 | £1,000 | 11.11 |
If the NAV rises to £110 per share, your investment will be worth:
| New NAV | New Share Price (After Discount) | New Value of Investment |
|---|---|---|
| £110 | £99 | £1,099 |
On the other hand, if you invest in a fund where you pay £100 per share, your investment will be worth:
| Fund NAV | Investment Value |
|---|---|
| £100 | £1,100 |
Comparison Table: Performance Potential
| Feature | Investment Trusts | Funds |
|---|---|---|
| Price vs. NAV | Can trade at a premium or discount to NAV | Trades at NAV |
| Return Potential | Can benefit from discounts, but risk of underperformance | Actively managed funds may have higher returns, passive funds tend to be more stable |
4. Management and Strategy
When choosing between investment trusts and funds, it’s important to understand the difference in how they’re managed.
Investment Trusts: Investment trusts are usually managed by a team of professionals who make decisions about what to invest in. However, they also have a lot of freedom when it comes to the types of assets they can hold. This can lead to more dynamic strategies and the potential for higher returns, but it also introduces greater risk.
Funds: Funds, especially mutual funds, tend to be more diversified, which can reduce risk. The fund manager will make decisions about where to invest, but in passively managed funds, these decisions are minimal. In ETFs, the strategy is typically more straightforward, tracking an index or following a passive strategy.
5. Tax Efficiency
Tax efficiency is a key factor in determining which investment is right for you. Different countries have different tax rules that apply to investment trusts and funds, so you’ll need to consider how taxes will impact your returns.
Investment Trusts: Investment trusts can be tax-efficient for higher-rate taxpayers due to their closed-ended structure, and in some jurisdictions, they may offer specific tax advantages that open-ended funds don’t.
Funds: Funds are generally less tax-efficient, particularly if you’re investing in actively managed funds. However, passively managed funds may be more tax-efficient since they tend to have fewer transactions and capital gains distributions.
Conclusion
The decision between investment trusts and funds ultimately depends on your individual financial goals, risk tolerance, and investment preferences. Investment trusts might be the right choice for investors looking for the potential of higher returns through trading at a discount or premium to NAV. They offer more flexibility, but they also come with higher risk. On the other hand, funds, particularly ETFs and passively managed funds, tend to offer lower costs, better liquidity, and less risk, but they may not provide the same upside potential as investment trusts.
As with all investment decisions, I recommend carefully considering your own financial situation, goals, and preferences before deciding which option best suits your needs.
