Unit trusts vs investment trusts: which performs better?

With input from our partners at Alliance Trust

When it comes to investing in collective funds, we have a few choices. There are ‘passive’ funds, such as ETFs, which track indices like the FTSE100 and aim to replicate their risk and return profile by buying the same stocks or a sample of such; or there are ‘active’ funds, whose portfolio managers carefully select potentially lucrative investment opportunities from within a particular market. Given how polarised and volatile stock markets are currently, an active approach gives investors the comfort of a professional investment manager steering their wealth through the uncertainty. 

If an active approach suits your taste, then in the UK you have two further options: unit trusts & open-ended investment companies (OEICs), often referred to as ‘funds’; or investment trusts, often called just ‘trusts’.

Funds are the mainstay of the industry, with around 5,000 available for us to choose from. Their key feature is that they expand or contract, much like an accordion, depending on demand and whether investors are stuffing cash into the fund or withdrawing it – hence ‘open-ended’. 

Investment trusts, on the other hand, have a fixed amount of cash to invest. If you want to buy into them, you must buy their shares which are traded separately on a stock exchange – similar to buying the shares of BP or Vodafone. With around 400 on offer, they represent a much smaller part of the industry that is also very old – Alliance Trust itself was launched in 1888.

Investment trusts come with a host of features that can make them seem more complicated than funds. Yet, it is through these features that they offer private investors some serious benefits. There is a reason why they are often described as the industry’s best kept secret – and it starts with performance.

A star performer

A successful investment strategy won’t excite the thrill seekers – patience and lengthy periods of time in the markets is key to building wealth. In other words, we must nurture our investments and give them a chance to grow. When deciding if funds or trusts represent the best long-term investment opportunity, performance data that pits the two against each other reveals some compelling insights. 

Below, we look at sector investment performance data from the last ten years up to June this year, compiled by the association of investment companies (AIC) – the industry body for investment trusts – and Morningstar, a data provider. 

It shows that over shorter periods of time, on average, funds just outperform trusts. Yet, over longer periods of time, trusts increasingly outperform open-ended funds. When it gets to 10 years or longer – the ideal minimum timeframe for investing – trusts outperform funds in 11 out of the 16 sectors analysed, an undeniable achievement. 

Importantly, this isn’t down the luck – there are a host of reasons why investment trusts tend to outperform funds. 

Gearing-up for a long-term approach

One very important feature of investment trusts that contributes strongly to performance is their ability to gear – in other words, borrow extra money to make investments beyond what the trust’s capital would allow. Imagine it much like taking out a mortgage to buy a property. Some trusts may have long term gearing in place; others may have much more flexible arrangements in place, a bit like an overdraft. 

Importantly, gearing exaggerates returns: boosting gains but also increasing potential loses too. Often, the facility is described as a double-edged sword, requiring the fund manager to wield it with skill. As a result, it can make the trust’s performance more volatile and is why over shorter periods of time open-ended funds may do better, depending on market conditions; but, similarly why over longer periods, when markets generally rise and the ups and downs of cycles are ironed out, trusts tend to win.

In addition, fund managers at the helm of investment trusts can use gearing facilities during times when markets panic and generally oversell, investing the cash on hand in the bargains left lying around. What is more, because the trust’s pool of capital is ringfenced, assets won’t need selling at low prices to raise cash if investors want their money back, as they would with our accordion-like open-ended funds. 

Finally, there is the trust’s independent board – another unique feature. Governing the trust’s activities, boards are comprised of experts across legal, accounting, and investing, who will oversee the investment professionals running the strategy and ensure they are keeping to their investment mandate. Ultimately, if investments aren’t being managed to a high enough standard, the board can fire the manager and replace them with someone else. 

The proof of the pudding

When it comes to achieving our financial goals, any sensible investing strategy involves investing for the long term. While investment trusts are nuanced and may appear complex, it is these very features that serve long term investors well. And the proof of the pudding is in the eating: the data shows that, on average, investment trusts beat open-ended funds when given the time to do so. For these reasons, we believe investment trusts are the perfect investment for private investors seeking to build their wealth over the long term. 

Alliance Trust is an investment trust with a history stretching back to 1888, and has been serving investors for generations. For more on Alliance Trust and its strategy, please find out more here. 

The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as at August 2022 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Towers Watson Investment Management Limited (“TWIM”) of 51 Lime Street, London, EC3M 7DQ, is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA Register Firm Reference Number 446740, refer to the FCA register for further details) and incorporated in England and Wales with Company Number 05534464. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.

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Marcus De Silva
Date published:
11 / 11 / 2022
Reading Time:
4 minutes