Unit and Investment Trusts: Two trusts: spot the differences

Unit and investment trusts are the ideal way for small investors to buy into the world's stock markets.

Although, over time, stock market investments outperform money placed in building society accounts or gilts and other fixed-interest securities, direct investment in shares is risky. The more shares you buy the more the risk is diluted, but some stockbrokers believe an investor should have at least pounds 100,000 to spend.

Unit and investment trusts pool savings to buy a wide range of shares. However, the two types of trust vary in several important ways, and anyone wanting to invest should be aware of the differences.

q Unit trust funds are divided into units. Each unit represents an equal proportion of the value of the fund's underlying investments. Investment trusts, on the other hand, issue shares. They are set up as companies, with the shares traded on the stock market.

q Unit trusts are open-ended funds. The fund manager is always happy to take more money to invest. However, if share prices tumble, unit trust managers may have to sell some of their better investments to pay people who want to cash in their money. By contrast, investment trusts are closed- end funds. Shares are on the stock market from someone who wants to sell. The assets of the trust are unaffected by this. This means an investment trust manager can ride out a stock market panic.

q Although the closed-end nature of the investment trust would seem to make it less of a risk, the opposite can be true. The value of units in a unit trusts reflects the value of the underlying investments. But the value of investment trust shares is determined by supply and demand in the stock market. Investment trust shares have traditionally traded at a discount to the underlying value - the share price does not fully reflect the value of the investments. At the same time, some successful trusts trade at a premium.

Before buying shares you might decide that a trust is trading at a discount that is likely to narrow, enabling you benefit as the share price rises. Alternatively if the trust is trading at a large premium, you might get better value elsewhere.

q Investment trusts can borrow money to invest. The advantage is that if the investment returns exceed the interest payable on the borrowings, returns are greater.

q Broadly speaking, all units in a unit trust have the same value and status. But some investment trusts have a range ofshares that carry different rights to the investment returns. At their simplest, some shares get the capital growth, the rest get the income. But there are lots of variations.

q Unit trusts have an identifiable difference between the higher offer price at which you buy into a fund and the lower bid price at which you sell units back to the fund manager.

Charges for an investment trust include the cost of using a stockbroker and stamp duty. There is also the difference between the buying and selling price of shares.