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Investment trust or investment fund?

The debate about the relative benefits of investments trusts and investment funds (unit trusts and OEICs) could be coming back into focus.

Investment trusts have a history going back over 150 years, long before the first unit trust appeared in 1931 or, later still, the birth of the open-ended investment company (OEIC). The major difference between investment trusts and their investment fund upstarts is the way in which they are structured:

  • An investment trust is a limited company with a fixed number of shares which investors can buy or sell on the stock exchange. That fixed number means that investment trusts are often referred to as closed-ended.
  • A unit trust or OEIC operates as an open-ended fund. Their managers can create or liquidate units/shares depending upon investor demand. A successful unit trust or OEIC can grow rapidly in size, whereas an investment trust generally cannot.

The tax rules for investment trusts are broadly similar to those for investment funds, but on the income front there is one difference which has suddenly assumed more importance. After deducting charges, the income from investments held by unit trusts and OEICs must be 100% distributed to their investors.

In contrast, an investment trust can retain up to 15% of the income it receives. Over the years, investment trusts have used this distribution flexibility to create reserves to smooth the flow of dividends to their investors. As a result, some investment trusts can point to records of 40 or more consecutive years of dividend increases.

With many UK and overseas companies stopping dividend payments in the wake of the Covid-19 pandemic, dividend payments from many unit trusts and OEICs, particularly those that are income-oriented, are set to fall. However, some investment trusts with an income reserve may choose to run down their rainy-day cash and maintain dividends to their investors.

Ultimately the income difference is simply a question of timing: the investment trust that maintains its dividend today, despite lower income from its investments, held back income it could have paid out earlier. Nevertheless, that conservative approach does have an obvious appeal in today’s conditions.

There are other aspects of investment trusts which give unit trusts and OEICs the edge, so do take professional advice before choosing or making a switch between the two.

The value of your investment, and the income from it, can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

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