Investment trusts are beloved of many investors and have a rich history stretching back to the jute boom of the 19th century. Despite its longevity, the industry’s primacy has been usurped by a relatively young pretender in the form of open-ended funds.

The first such fund was launched by M&G in 1931 and these new(ish) entrants now account for around £1.5 trillion of investors’ money, compared to the £270 billion investment trust market. But just what are the salient differences between investment trusts and open-ended funds, and which should investors prefer?

DISCOUNTS, COMPLEXITY AND RISK

The short if unilluminating answer to the latter question is: it depends. Generally speaking, investment trusts are probably better suited to more experienced investors, while open-ended funds can be used by novices and seasoned pros alike. The fact investment trusts can trade at a discount or premium to the value of the underlying portfolio potentially generates buying and selling opportunities for astute, attentive investors. Discounts also boosts dividend yields for income-seekers. By the same token the existence of discounts and premiums creates added volatility and complexity, raising the somewhat vexing question about whether it’s a good entry or exit point from any given trust. Little wonder then some investors turn to open-ended funds for a simpler life, seeing as these trade at the value of the underlying portfolio. Investment trusts can also borrow to invest, and many do. This may well turbo-charge long term returns, but also tends to exacerbate losses in falling markets.

INTRA-DAY TRADING

Investment trusts also trade throughout the day, so when you buy or sell, you know precisely what price you’re getting. Open-ended funds work on a forward-pricing basis, so when you place a trade, it goes through at the price set at the next valuation point, often noon the following day.

If you’re a tactical investor who likes to know the precise terms of your trades, then investment trusts are therefore probably more appealing. But for long-term, buy-and-hold investors, the ability to trade throughout the day isn’t such an obvious advantage. If you’re going to be invested for 20 years, it won’t make a great deal of difference to your overall returns whether you buy in at 3pm today, or midday tomorrow, unless there is an almighty one day move in the market. And of course, any move could always be in your favour.

BROADER CHOICE

There is a wider range of choice amongst open-ended funds than investment trusts. It’s simply a numbers game. Just looking at the global equity sector, there are 13 investment trusts available, compared to over 500 open-ended funds. That leads to a broader selection of managers and strategies on offer in the open-ended fund world. This is particularly relevant for those investors who want to gain passive exposure to global markets. There are no investment trusts which simply track a stock market index, whereas this has been an immensely popular approach with open-ended fund investors in recent years.

ILLIQUID ASSETS

Despite there being fewer trusts in absolute terms, there are some areas of the market where investment trusts come into their own, such as illiquid assets. These are assets which can’t be sold quickly, such as infrastructure projects, commercial properties, or unlisted shares. Investing in such assets in open-ended funds comes with a fundamental problem: fund investors can ask for their money back at any time, but the stuff the fund is invested in can’t be sold at the drop of the hat. This mismatch was responsible for the downfall of the Woodford empire and led to open-ended property funds having to suspend trading during periods of market turbulence.

Investment trusts don’t suffer from the same difficulty. Their closed-ended structure means there are no daily flows into or out of the trust itself. Shares in the trust are traded on the secondary market between investors, and at times of market stress, investors can still buy and sell. Discounts will almost certainly widen substantially in this scenario, so there is a price for liquidity, but at least it is there.

INCOME INVESTING

Investment trusts can also be useful for income-seekers, because of a mechanism that allows them to hold back dividends to be paid out in years when there is a dearth of natural income generated by the underlying portfolio. That doesn’t mean an investment trust receives more dividends from its portfolio than an equivalent open-ended fund, but it can smooth out the lumpiness of income distributions for investors. Hence why some investment trusts dubbed ‘dividend heroes’ have been able to increase their dividends every year for more than 50 years.

THE WOOD FOR THE TREES

While the differences between open-ended funds and investment trusts are of course pertinent to investment decisions, it’s important not to lose sight of the wood for the trees. Considerations like the quality of the fund manager, the suitability of the investment strategy, and the annual charges of prospective investments are almost certainly more important than whether the structure of the fund is open or closed-ended.

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