'Forgotten man' with a record to be proud of

Investment trusts have not been as popular with investors as unit trusts. But, Harvey Jones says, as a whole their returns have been greater

Investment trusts have long been the forgotten man of the investment world. If you don't understand how they work, or have never heard of them, you are not alone. Even more experienced private investors tend to pass them by, preferring unit trusts for their stock and share Isas.

Investment trusts have long been the forgotten man of the investment world. If you don't understand how they work, or have never heard of them, you are not alone. Even more experienced private investors tend to pass them by, preferring unit trusts for their stock and share Isas.

Investment trusts are stepping up their campaign to persuade investors that they represent a good home for their money. You may have spotted the latest phase of the multi-million pound "its" campaign on your TV. Should you be swayed?

Recent performance has certainly been good news for those wanting investment growth. Average investment trust returns easily outstrip bank and building society savings accounts. If you had invested £1,000 on 31 December 1990 you would have had £4,021 10 years later, compared to £1,424 in the average building society account.

But they have also outstripped a far more popular and widely understood stock market investment vehicle, unit trusts. The average unit trust in the All Companies sector grew £3,602 over the same period. Recent stock market volatility appears to have hit unit trusts harder than investment trusts.

Martyn Page, head of research at Countrywide Independent Advisers, warns that individual investment trust performance can differ greatly, and investors should tread carefully when picking a trust. "There are some very useful investment trusts out there, but many are highly risky and should be avoided. Make sure you know what you are buying, and only invest for the longer term," he said.

Investment trusts and unit trusts have much in common. Both are collective equity investments that reduce the risk of investing in the stock market by spreading your money across a range of different companies. They are sold by major fund managers such as Aberdeen, Fidelity, Henderson, Jupiter and Schroder, and can be used as the underlying fund in your Isa.

But investment trusts are more complex than unit trusts, a factor that has almost certainly dented their popularity. While unit trusts simply divide a pooled fund of stocks and shares into equal units and issue them to investors, investment trusts are companies quoted on the stock exchange, which invest in other companies' shares.

The trust's own shares also traded on the stock market and, like all shares, their price is determined by how much investors are willing to pay for them. When demand rises, their share price increases.

Page says many investors are confused because there can be a difference between the trust's share price and the value of its underlying investments. When the share price is higher than the value of the trust's assets, it is said to be "at a premium", and when lower it is "at a discount".

The average investment trust is currently trading at a 10 per cent discount. This means 10p will buy you £1 worth of shares, but dividends will still be based on the full £1 price. This looks like a bargain, but Page warns there are dangers. "You may be buying the shares cheap, but if that discount does not close by the time you come to sell, and there is no guarantee it will, then it hardly represents a bargain. Worse, the discount could widen further, and you could lose out." This makes investment trusts more volatile than unit trusts - and potentially more rewarding.

The good news in recent months is that investment trust discounts generally have been closing. Among the major trusts, Foreign & Colonial's discount has fallen from 15 per cent to 12 per cent over the last year, while another long-standing and popular trust, Witan, has seen its discount close from 15 per cent to 9 per cent.

Annabel Brodie-Smith, communications director at the Association of Investment Trust Companies, says this is partly due to the recent investment trust publicity campaign, and efforts by individual trusts to boost their profile. "Investment trusts have had a good year for a number of reasons. Performance has been extremely good at a difficult time, and there has been increased demand from individual investors," she said.

Sales of investment trust Isas rose 71 per cent to £42m in the three months to October 2000 compared to the same period the previous year, when £25m were sold. But this still makes them small fry compared to unit trusts, which sold £2bn worth of Isas in the same period.

Investment trusts have traditionally had one clear advantage over unit trusts - they have been much cheaper to buy, says Patrick Connolly, associate director of the financial advisers Chartwell Investment Management.

While unit trusts impose initial charges of up to 5.25 per cent and annual management fees of up to 1.5 per cent, investment trusts often have no initial charges and annual charges of less than 1 per cent. You must also pay stamp duty on share purchases at 0.5 per cent. "Charges are not the overriding consideration when choosing an investment, but they can make a difference in the longer run," he says.

One reason charges are lower is that few investment trusts pay commission to financial advisers for recommending them. "Most pay no commission whatsoever, so advisers are reluctant to recommend them, unless they charge a fee for their services. However, a growing number will pay commission to advisers, so check carefully and understand the level of charges you are incurring," Connelly says.

His favourite investment trusts include Liontrust First UK from Liontrust Investment Services which grew 38 per cent over the last three years, according to figures from Micropal. He believes Europe offers strong investment opportunities at the moment, and recommends TR European Growth from Henderson Investors, which grew 99 per cent over the last three years, and Gartmore European, which grew 105 per cent over the same period.

Page's preferred investment trusts include Aurora from Mars Asset Management, which grew 88 per cent over the last three years, and Scottish Value Management's Under Value Assets fund, which grew 42 per cent over the last five years. He says some of the most spectacular investment trust growth has come in the venture and development capital sector.

Figures from Lipper show the leading investment trust in this sector grew a whopping 5978 per cent over the last five years (see table). A number of trusts in the biotechnology and life sciences sector have also performed strongly. But these sectors can be highly risky and are not for nervous investors.

Contacts: Mars Asset Management 020-7410 0025; Gartmore 020-7782 2000; Henderson Investors 020-7410 4100; Liontrust Investment Services 020-7412 1700; Scottish Value Management 0131-226 6699; Chartwell Investment Management 01225 446556; Countrywide Independent Advisers 01865 886000; Association of Investment Trust Companies 0800 085 8520 or www.itsonline.co.uk