You will sometimes find that investment companies offer you a choice between a unit or investment trust with virtually identical portfolios. Which should you go for? The answer is not clear-cut. But you may possibly be able to enhance your returns by relating your decision to your overall investment strategy.
Unit trusts are revalued every day to reflect the worth of their underlying assets. That is to say, if a unit trust owns shares and cash worth 5x and has issued 5m units, then roughly speaking each unit will be valued at 1 millionth of x.
By contrast, nearly all investment trusts have historically traded at a discount to their underlying assets. That is to say, they have usually owned shares worth a total of, say, 5x, while the value of shares in the trust itself has only come to, say, 4x. In this hypothetical case, the discount would be 20%. Figures for discounts or, in some cases, premiums are listed each day in the Financial Times.
Discounts move about according to how highly investors rate the trust or market concerned. In other words, they can expand or contract rather like P/E ratios. This can give a substantial kick to any rise in the share price:
| Rise in share price | |
|---|---|
| Share price 80p, assets rise 50%, 20% discount stays constant Assets worth 150p ( 0.8 = Share price of 120p) | 50% |
| Share price 80p, assets rise 50%, 20% discount narrows to 10% Assets worth 150p ( 0.9 = Share price of 135p ) | 68.75% |
| Share price 80p, assets rise 50%, 20% discount narrows to zero Assets worth 150p ( 1 = Share price of 150p ) | 87.5% |
Suppose you are a value investor entering a market you believe to be heavily underrated. So long as you are confident discounts will narrow over time, once investors take a more optimistic view, you should probably choose an investment trust rather than a unit trust. If you prove right, this will deliver more bang for your buck.
But always be aware that this effect cuts both ways. If the discount widens instead, it could slash your profits or even wipe them out altogether.
For growth investors, the decision is more finely balanced. Any trust that is already rated for its growth is unlikely to stand on a large discount. In fact, there may be more risk of the discount widening as investors begin to anticipate a slowdown in growth. So generally speaking, as a growth investor you should opt for unit trusts. This will enable you to benefit straightforwardly from any growth in the underlying assets.
One final tip: If you wish to protect any gains on your trusts from tax, you should be able to hold them in an ISA, provided they are 'authorised UK trusts'. Check this with your broker or fund manager.
Different rules apply to PEPs, which were mainly designed to hold UK investments rather than foreign ones. But surprisingly often a foreign trust does qualify as a UK investment, thanks to some quirk in the rules. Again, it is worth checking before you buy.
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