Investment Trust vs. Mutual Fund: Key Differences

Both investment trusts and mutual funds offer investors a way to pool their money together and invest in a diversified portfolio managed by professionals. However, they operate under different structures, leading to distinct characteristics that can influence investment decisions.

Structure & Trading

A mutual fund is an open-ended investment, meaning the fund creates new shares to meet investor demand. Investors buy and sell shares directly from the fund at a price based on the fund’s Net Asset Value (NAV) calculated at the end of each trading day. This NAV reflects the total value of the fund’s assets minus liabilities, divided by the number of outstanding shares.

An investment trust, also known as a closed-end fund, operates with a fixed number of shares. These shares are initially offered through an IPO and then traded on a stock exchange like any other publicly listed company. The share price is determined by market supply and demand, and may trade at a premium (above NAV) or a discount (below NAV) to its underlying asset value. This premium or discount can fluctuate based on investor sentiment and market conditions.

Pricing & Volatility

The NAV pricing of mutual funds offers transparency and ensures investors buy or sell at a fair value reflective of the underlying assets. Because investment trust shares trade on the open market, their price can be more volatile due to market sentiment. The discount or premium to NAV can widen or narrow, impacting returns independently of the underlying asset performance.

Management & Fees

Both investment trusts and mutual funds charge management fees to cover the costs of running the fund. However, investment trusts often have lower ongoing expenses than mutual funds. This can be due to their fixed capital structure, which may reduce administrative costs. However, it is essential to consider all costs, including brokerage fees for trading investment trust shares.

Portfolio Flexibility

Investment trusts have more flexibility in their investment strategies. They can borrow money (gearing or leverage) to enhance returns, but this also increases risk. They can also invest in unlisted companies, giving them access to potentially higher growth opportunities not available to mutual funds. Mutual funds generally have stricter regulations limiting their ability to borrow or invest in illiquid assets.

Income Distribution

Both types of funds distribute income to shareholders, but the timing and frequency may differ. Investment trusts sometimes hold back a portion of the income to smooth dividend payments over time, offering a more consistent income stream.

Which is Right for You?

The choice between an investment trust and a mutual fund depends on your individual investment goals, risk tolerance, and investment horizon. If you prioritize transparency and NAV pricing, a mutual fund might be suitable. If you are comfortable with market volatility and potentially benefiting from a discount to NAV, while accepting the risks of gearing, an investment trust could be considered. Thorough research and understanding the specific characteristics of each fund are crucial before making any investment decisions.