Most people who invest through an ISA or pension are doing so via open-ended funds, often without knowing there’s an alternative. Investment trusts, the closed-ended counterpart, have been around since the 1860s and have structural characteristics that make them genuinely different from funds in ways that matter for long-term investors. Understanding what those differences are, and when each structure is better suited to the investor’s objectives, is worth the time it takes.
The Structural Difference
An open-ended fund creates and redeems units as investors buy and sell. The size of the fund grows when more people invest and shrinks when they withdraw. The price of a unit is directly tied to the net asset value of the underlying holdings, calculated once per day.
An investment trust is a listed company. It issues a fixed number of shares, which trade on a stock exchange throughout the day. The size of the trust doesn’t change when investors buy and sell shares; what changes is who owns those shares and at what price. The share price is set by supply and demand in the market rather than directly by the net asset value of the underlying portfolio.
This structural difference produces several practical consequences that are significant for investors.
Discounts and Premiums
Because an investment trust’s share price is set by market demand rather than asset value, it can trade at a discount or a premium to its net asset value (NAV). When sentiment toward a trust or its sector is weak, shares may trade at a discount, meaning you can buy a pound’s worth of underlying assets for less than a pound. When sentiment is strong, a trust may trade at a premium.
For long-term investors, buying at a discount to NAV represents potential additional upside: if the discount narrows, you benefit from both the underlying portfolio performance and the discount closing. Identifying the best investment trusts often involves looking at historical discount levels and considering whether the current discount represents a genuine opportunity or reflects a structural problem with the trust.
The risk runs in both directions: a trust bought at a narrow discount or premium can see that discount widen, adding to losses even if the underlying portfolio performs adequately. Understanding the discount history of a trust, and what drives it, is part of evaluating whether it’s suitable.
The Gearing Advantage and Risk
Investment trusts can borrow to invest, a practice called gearing. If the trust borrows at 5% and the portfolio returns 10%, the difference accrues to shareholders. If the portfolio returns 3%, the borrowing has cost more than it produced.
Gearing amplifies both gains and losses. In a rising market, a geared trust outperforms an equivalent ungeared open-ended fund. In a falling market, it underperforms. For long-term investors who can tolerate this additional volatility and who are investing over a horizon long enough for the benefit of leverage to compound, the gearing available in investment trusts is a structural advantage that open-ended funds can’t replicate.
The degree of gearing varies considerably between trusts and should be checked before investing. A trust with 30% gearing is taking meaningfully more risk than one with 10%, all else being equal.
The Illiquid Assets Question
One of the more significant practical advantages of the investment trust structure for long-term investors is its ability to hold illiquid assets. Because the trust doesn’t need to meet redemptions, the manager can hold private equity, infrastructure, property, and other assets that cannot be quickly sold without facing a forced seller’s dilemma.
Open-ended funds that hold illiquid assets face a structural mismatch: daily liquidity for investors, but underlying holdings that can take months or years to sell at fair value. This mismatch caused problems in several UK property funds when investors sought redemptions simultaneously, and the funds had to suspend dealing because they couldn’t sell underlying properties fast enough.
Investment trusts don’t have this problem. The manager’s investment horizon and the portfolio’s liquidity requirements are aligned, which allows genuine allocation to illiquid premiums that add return over time.
Costs and Charges
Investment trust charges are structured differently from open-ended funds, and comparisons need to account for this. The ongoing charge of an investment trust typically covers management fees and operational costs, but the cost of buying and selling shares (brokerage, stamp duty, the bid-offer spread) adds to the total cost of investing.
For long-term buy-and-hold investors, these transaction costs are a one-time entry and exit cost rather than an ongoing drag. For investors who trade frequently, they add up. The cost comparison between a trust and an equivalent open-ended fund therefore depends in part on how long the investment is held and how frequently the investor transacts.
Which Structure Suits Long-Term Investors?
The case for investment trusts for long-term investors rests on several of the characteristics above: the ability to access illiquid asset premiums, the potential to buy at a discount to NAV, the compounding benefit of gearing in rising markets over long periods, and the stability of the closed-ended structure that allows managers to invest without worrying about redemption flows.
Open-ended funds are simpler, more transparent in pricing, and better suited to investors who need predictable liquidity or who prefer not to monitor discount and premium dynamics.
For a long-term investor building a diversified portfolio and not requiring regular access to the invested capital, investment trusts offer structural characteristics that open-ended funds don’t, and the best examples of each asset class often exist in trust form rather than as open-ended funds. Understanding both structures and using each where it’s best suited produces a more complete and efficient portfolio than defaulting to one format regardless of its fit.
