Funds vs Trusts

Both funds and trusts are collective, or pooled investments; that is, they pool the money of large numbers of individual investors to create a much larger amount of money which can then be invested. Also, they both use a fund manager to decide which companies to buy with the investors’ money. Funds are also known as open ended investment companies, or OEICs, and unit trusts in the UK. By definition they are open ended companies. That means when new investors come along with money to invest, new units in the fund are created and the fund grows.
Similarly, when investors want their money back, the fund shrinks as the units are cancelled. Investment trusts are different in that in principle there are a fixed number of shares in issue, so in order for an investor to buy shares another investor must be prepared to sell. This is the main difference.
So, what’s the impact of the closed- and open-ended structure for investors? Firstly, in extreme market conditions, investors often want to move into cash. Managers of funds sell assets to achieve this and if they need to sell at a loss, returns for investors are affected. Investment trusts, on the other hand, match sellers to buyers so the manager can avoid being forced to sell investments in a falling market. A trust can also borrow money or ‘gear’ to enhance returns in a rising market. Investment funds cannot don’t normally do this.
Gearing allows the manager to take advantage of opportunities he would otherwise be able to access, but he must ensure that the return he gets from that opportunity outweighs the cost of borrowing the money in the first place. Finally, investment trusts can retain up to 15% of the income they get as dividends from the companies in which they are invested whereas funds have to pay out all the income they receive. This means investment trusts can smooth out the paying of income by keeping back money to pay out in years when they don’t get so much money in.