An open and shut argument

Indeed, as a much younger stockbroker, I was responsible for setting up the Unit Trust Advisory Service for Hoare Govett, though both that body and its distinguished City name have long since disappeared.

Investment trusts suffered a setback 15 or so years ago when some managers got caught up in the split-cap scandal, which led to mis-selling allegations and heavy fines levied by the regulator. Then came a period of time when advisers were reluctant to recommend investment trusts because of this and worries about liquidity.

Investment Trusts, of course, are close-ended investments and this gives them several advantages over unit trusts and Oeics. For a start, this structure means they generally have a fixed amount of assets and they do not automatically increase or decrease in size if money enters or leaves the funds. This means the fund managers can take a long-term view of the market.

Unit Trusts and Oeics, on the other hand, expand or contract depending on supply and demand. In their case, fund managers have to manage fluctuations in the size of the fund as clients either invest or withdraw money, and so in tough or difficult markets the managers can be forced to sell assets to meet redemptions. However, the flexibility that unit trusts and Oeics offer when it comes to investing as little as £25 regularly or a £500 lump sum means relatively painless access to stock market investment.

Unlike both unit and investment trusts, the appeal of the Oeic is that it has no spread between bid and offer

Investment trusts are also traded on a recognised stock exchange and therefore are regulated by company law and listing rules. This gives investors the flexibility to buy and sell their shares at a quoted price.

That price is affected by market sentiment as well as performance of the underlying assets of the fund, giving the investor a transparent choice over whether to buy or sell, whereas unit trust funds and Oeics depend on the value of the underlying assets at the time the investor may wish to withdraw cash. On the other hand, being open-ended means that investors can freely buy or sell shares in the fund by buying or selling ‘units’, avoiding the lack of liquidity that affects many investment trusts.

Unlike both unit and investment trusts, the appeal of the Oeic is that it has no spread between bid and offer as all shares are bought and sold at the same price, so there is no need to work out the spread.

There is a view that as shareholders, rather than unit holders, investors in investment trusts have much more influence on governance and management – voting on key issues and attending annual general meetings – than investors in Oeics.

In general, unit trusts, Oeics and investment trusts invest in similar sectors, focusing on those that provide income, growth or a combination of the two, whether in the UK, Europe, emerging markets or other parts of the world. However, investment trusts, being closed-ended, have the freedom to invest in almost any type of asset including property, private equity or hedge funds, which are more illiquid than other more traditional assets.

The structure of investment companies also gives them an advantage when it comes to paying dividends. They can keep up to 15 per cent of each year’s income to boost dividends in lean years whereas unit trusts have to distribute all their income each year. This has allowed investment trusts to build up an unrivalled track record for paying dividends, with many having increased them year-on-year for decades.

In fact, research by the Association of Investment Companies shows that 20 per cent of its members have increased dividends for at least 10 years in a row. Half of the trusts in the UK equity income sector have done so, while 29 per cent of those investing in UK smaller companies have done the same. Some of the older investment companies have managed to raise their dividends year-on-year for the past 20 years.

So it is no wonder that professional advisers are, at last, beginning to appreciate the advantages of investment trusts over unit trusts and Oeics. In fact, purchases through platforms increased by 23 per cent to £342m during the first nine months of 2014.

While investment trusts do have distinctive advantages over unit trusts and Oeics, the simplicity of the latter does appeal. Oeics do have a sense of doing what it says on the tin about them.

But appreciating the advantages is not enough. In the post-retail distribution review era, advisers should be prepared to sacrifice a little short-term income by buying low-expense investment trusts rather than the more expensive – to buy and to run – unit trusts/Oeics for the longer-term benefit of their clients. However, one must not overlook the capital gains tax benefits that Unit Trusts/Oeics present. Although gains made on disposal are subject to tax, a fund itself does not pay any tax on capital gains, so that investors in Oeics and unit trusts can use their own annual CGT exemption to mitigate their tax position on any subsequent gains.

In fact, charges and fees should be considered. There is no initial charge when buying investment trusts, but stamp duty on investment is 0.5 per cent and a nominal £1 levied by the Panel of Takeovers and Mergers, while many unit trust and Oeic managers charge initial fees of up to 5 per cent and ongoing annual management fees, which do not apply to investment trusts.

One must not overlook the CGT benefits that investment trusts, unit Trusts and Oeics present.

Robin Boyle is managing director of Athelney Trust

Key points

Investment trust fund managers can take a long-term view, whereas Oeics managers can be forced to sell assets to meet redemptions in difficult markets.

The appeal of Oeics is they have no spread between bid and offer as all shares are bought and sold at the same price.

Iinvestment trusts have distinctive advantages over Oeics, but the simplicity of the latter is attractive – they do what they say on the tin.

There are CGT benefits with both types.