Ian Cowie: why I prefer investment trusts over funds

When can apparently technical differences between similar-sounding investments make you thousands of pounds better off? When one investment is an investment trust and the other is a unit trust, that’s when! 

Before your eyes glaze over, bear in mind that the City is full of plate-glass palaces paid for by people who couldn’t be bothered to consider the details. Remember, there is no magic to investment; the more you put in, the more you are likely to take out. 

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More positively, let me add that new research shows just how big the performance gap is between these two types of pooled funds.  

Many fund managers offer both unit and investment trusts, focused on identical sectors and sometimes called “sister funds”.  

But, because of those apparently technical differences I mentioned earlier, there is a massive difference in outcomes for the people putting money into these sister funds. 

To be specific, consider performance data from Morningstar, analysed by the Association of Investment Companies (AIC); full disclosure, the AIC represents investment trusts.  

Even so, the Morningstar data shows that 77% of investment trusts beat their unit trust sister funds over a decade, while 53% did so over five years and 82% won over the last year. 

In cash terms, investment trusts’ outperformance added £31 per £100 invested over a decade.  

So, individual shareholders ended up with nearly a third more than unit holders in the same sector.  

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Over shorter periods the gap was smaller, with £3 extra per £100 over five years, and £5 extra per £100 over the last year. 

Eagle-eyed readers will have noticed there wasn’t much difference over the medium period.  

The explanation is one of those technicalities mentioned earlier, so we had better get stuck into explaining them now. 

Both unit and investment trusts deliver a valuable service to diminish the dangers inherent in stock market investment by diversification.  

Both types of pooled funds spread individuals’ money over dozens of different underlying assets to reduce the risk of setbacks at any one company, country or currency causing catastrophic wealth destruction. If that sounds technical to you, just wait until the next stock market crash to find out why it is important. 

However - unavoidable jargon alert - investment trusts are closed-end funds and unit trusts are open-ended funds.  

Please bear with me. In plain English, that means investment trusts’ share prices are dictated by demand in the market for what is usually a fixed supply of shares, while unit prices are calculated by mathematical formula. 

This creates the possibility of investment trusts trading on the stock market at share prices that are lower than their net asset value (NAV) - when they are said to be priced at a “discount” - or, less often, above NAV, when they are said to be priced at a “premium”. 

By contrast, units are priced at or near to their NAV, regardless of stock market sentiment or investor demand. 

That explains why investment trusts’ outperformance over unit trusts was fairly muted over five years.  

Back in March 2021, the world was still celebrating the authorisation of the first Covid vaccine for Pfizer Inc (NYSE:PFE) the previous December and investment trusts were trading at an average discount of only 4%. 

Five years later, by March 2025, the world was worrying about American tariffs plus full-blown wars in the Middle East and Ukraine, depressing stock market sentiment and shareholder demand. That pushed the average investment trust discount out to 14% and reduced returns to shareholders over this period. 

But, crucially for long-term returns, investment trust fund managers were not forced to sell any assets because of the change in shareholder sentiment. By contrast, unit trust managers are required to sell assets to raise cash to meet redemptions. 

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Contrariwise, it is important to stress the potential for discounts to widen is not a risk that unit holders need to worry about. Even so, investment trusts still did better than their unit trust “sister funds” over the long, medium and short term. 

The technical reasons for such sustained outperformance also include investment trusts’ ability to borrow to invest.  

Also called “gearing” this is a double-edged sword which can increase returns and risks; depending on whether the assets bought with borrowed money deliver more growth and income than the cost of borrowing. 

Unit trusts are not allowed to borrow to invest, reducing returns and risks. Nick Britton, research director of the AIC, pointed out other important differences. He said: “Investment trusts’ closed-ended structure enables their managers to buy and sell assets at the time of their choosing, not when investors buy or sell. 

“They can invest in less liquid assets, such as smaller companies and even private companies, without worrying about having to sell them to meet redemptions. 

“Investment trusts won’t always outperform open-ended funds, especially in down markets when discounts tend to widen. But over a market cycle, investment trusts’ structural advantages support strong performance.” 

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Finally, for City cynics who say everybody knows about these technical differences, here’s another bit of research published this week.  

Despite the recent launch of the “Savvy the Squirrel” campaign to encourage stock market investment, nearly a fifth of Britons said they had never heard of investment trusts, according to the giant fund manager Investec. 

That was the average response across 2,000 adults but, among cash depositors in banks and building societies, a depressing two-thirds or 66% said they had never heard of investment trusts or did not understand what they are.  

By contrast, only 4% said they had never heard of cryptocurrencies or did not understand how they work. It’s enough to drive Savvy the Squirrel nuts! 

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie is a shareholder in Pfizer (PFE) as part of a globally diversified portfolio of investment trusts and other share.