Trust Me......Unit or Investment Trust?
Written by Niel Gavin on 13/06/2019

So Woodford.....who saw that coming? 

For years Neil Woodford was a standard for equity income that many wished they could emulate. 

Then out of the blue, bang! Woodford suspends clients from withdrawing funds and refuses to waive his fees.....trigger a mass exodus from his funds and pressure from several quarters for him to stop taking client's money when they can't trade! Even the FCA and MP's became involved (though MP's might have smelled a ripe carcass to pick at to improve their public profiles - yes I know I am cynical!) 

But it has raised a logical question, not about Neil Woodford, we all have our own opinions about the man and the £36.5 million that he took last year as personal income! No it raised this question: 

Unit Trust/OEIC or Investment Trust? 

Which is better to invest in? 

Now some will argue the case for both so I wanted to make my position known on this eternal question but let me start by outlining what makes them different....

What is the difference between them? 

A Unit Trust/OEIC is an open ended fund, this means that if there is demand for more units, then the fund manager can just create them, meaning that the manager can always accept more cash from investors by simply creating more units. However it does mean that if more people are selling than buying, the fund will shrink. This is a fund as most people know it. 

An Investment Trust is a closed company, meaning that the manager creates it, issues a set number of shares and that is it. If you want to invest in one after the initial offer of shares then you can buy them on a listed stock exchange as you would traditional shares. This means that this is a limited company and not really a fund. 

Now all investors really care about (and I can't blame them) is PERFORMANCE. 

Many state that Investment Trusts do better than Unit Trusts/OEICs, however this is a dangerous assumption and not quite accurate. 

There are some reasons why an Investment Trust can look better, for example: 

One reason is that investment trusts allow managers to take a longer-term view. This is because they do not have to sell assets when investors sell their shares..... In contrast, unit trusts do have to liquidate assets if investors want out, so do not bounce back up again so quickly as asset prices recover, imagine the effect of a large pension fund "dumping" a unit trust (this happens a lot more frequently than you might imagine) 

This effect is made worse by the fact that investors tend to want to exit their investments when the market is doing badly. This, of course, is the worst possible time to sell assets but sometimes you can't train out that knee jerk reaction in people! Goodness knows I have tried over 25 years. 

For this reason, investment trusts are more suitable for assets that are hard to sell quickly, like property and infrastructure. Unit trusts have to stick to easily sold (liquid) assets, like shares. All the same, in a difficult market they will struggle to offload their bad assets, so will be forced to sell their good ones. 

Another advantage investment trust managers have is that they can accrue revenue reserves. Unit trusts distribute their income on an annual basis, while investment trusts can keep up to 15 per cent of it in reserve for a rainy day. Despite the widespread dividend cuts around 2008 and 2009, many investment trusts were still able to maintain their records of paying out and growing dividends – even in the face of a drop in underlying earnings. (now if you are a fan of "smoothing" this will strike an accord with you) 

In this way, investment trusts have the ability to preserve cash in good times and distribute it in bad times, thereby keeping income steady for shareholders (see volatility controls) 

Investment trusts are also subject to market discipline. If performance dips, the board of the investment trust can hold the fund manager to account and, in extreme cases, replace him. In theory, this separation between the trust’s board and the fund manager should act in shareholders’ best interests. 

All good reasons so far......but 

A final reason for the difference in performance over the long term is the fact that many investment trusts (though not all) use gearing. This is a technical term for borrowing money, which provides a boost to returns when markets rise, as well as a drag when they fall. 

There are other reasons why people might consider Investment Trusts more attractive: 

Unit trusts are only priced once a day, so potential investors do not have perfect visibility over the price they will have to pay. Investment trusts are traded freely over the stock market, so investors generally have better sight of what they will have to pay for shares, although they will have to cope with the bid-offer spread and dealing costs. 

Shareholders in investment trusts can further benefit if the shares are undervalued (discounted). This happens when the price of each share is less than the value of all assets held in the company divided by the number of shares (known as net asset value or NAV per share). 

Although there is nothing to say this ‘discount to NAV’ will definitely narrow, it offers investors willing to take on risk the chance to boost their returns. Investors can potentially buy in at a discount and then, as market sentiment revives, reap the rewards of improvements in both the underlying value of the assets and the narrowing of the discount – or at least that’s the hope, you don't get that with Unit Trusts. 

The flip side of this argument is that the separation between share price and NAV introduces an element of complexity and unpredictability into investment trusts. If you buy at a premium and sell at a discount, you’ll do worse than someone who invested in an equivalent unit trust but then if you take advice and invest with diligence this should not be an issue. 

The two vehicles are similar in terms of cost. Fans of investment trusts argue that they’re cheaper because they have lower running expenses, but this is hard to quantify because some of their costs are absorbed in the company accounts. 

There are other fees and costs to bear in mind though. For unit trusts, there’s an initial charge, a one-off payment which is a percentage of the amount invested (usually 4 or 5 per cent). This is heavily discounted, often to zero, when you invest through online fund platforms and of course the more modern OEIC has a single price. 

Many people invest in either through a platform and here is one area where the Investment Trust can have the edge, platforms charge differently for unit trusts and investment trusts. To generalise, if you are not going to be trading very frequently and you have at least £10,000 invested, you are almost certainly going to pay less in platform and dealing fees with investment trusts as opposed to unit trusts. This is because platforms tend to charge a percentage fee for your holdings in open-ended funds, which is either uncapped or capped at a very high level. 

For investment trusts, platforms may charge a flat fee, no fee, or a percentage fee with a lower cap. 

Bear in mind, though, that many platforms do not charge you to buy or sell unit trusts, but all platforms will charge you to deal in investment trusts. 

Performance 

Research on the performance of investment trusts versus unit trusts regularly shows that investment trusts do better in the vast majority of sectors when you look at longer periods of ten years or more (which let's face it is the bulk of most advisers' work) 

However, if you look at a shorter period, say one to five years, investment trusts are less likely to beat unit trusts. They also offer investors a bumpier investment journey, with more exaggerated ups and downs in their share prices. For investors fond of the quiet life, unit trusts are attractive because they are less volatile in the shorter term, though bear in mind that we said earlier that Investment Trusts can hold back some profits in order to stabilise potential returns for investors. 

The CASS business school at the tail end of 2018 published research regarding this question and Morningstar ran an article about it, http://www.morningstar.co.uk/uk/news/168601/why-do-investment-trusts-outperform.aspx 

One of their points was that even setting aside structural factors such as holding more illiquid assets, or smaller companies, investment trusts still showed significant outperformance over their benchmarks and open-ended peers. This had little to do with advantages such as gearing and far more to do with the flexibility that the structure provides managers. 

The research showed that even taking buybacks, a structural weight to smaller companies, gearing and portfolio construction issues into account, closed ended funds outperformed open-ended funds by around 80 basis points – 0.8% 

So what is the answer here? Unit Trust or Investment Trust? 

There is no one size fits all answer I am afraid but research seems to be telling us that over the longer term the Investment Trust offers greater potential returns and in the shorter term it's the Unit Trust or OEIC that has the edge. 

I think that what I am saying here is you must not discount the Investment Trust, despite the historical side-lining to the Unit Trust or OEIC, they can offer the longer term investor advantages over the more widely sold cousin, the Unit Trust or OEIC.....this will come back to one of my favourite issues (and if you have been reading my "stuff" lately you'll know) know your client!

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