Funds vs investment trusts: 4 key differences explained

It is easy to think of funds and investment trusts as virtually interchangeable, but there are some important differences between them that can have a big impact on the potential risk and return. These need to be taken into account at the research stage to make sure that you get the sort of exposure that you want.

The key point to understand is that funds are open-ended, so whenever someone invests, new units are created and the cash goes into the portfolio for the manager to deploy. Where an existing investor sells, their units are cancelled and assets have to be sold to pay for the redemption.

• Read: How mutual funds work

Investment trusts are closed-ended, because they issue a fixed number of shares with the proceeds providing a ‘permanent’ pool of capital for the manager to invest. The shares are then traded throughout the day on the London Stock Exchange (LSE) with the transactions not affecting the underlying portfolio.

• Read: How investment trusts work

These structural differences – and the rules that govern them − can impact the risk/return profile in a number of ways, with the following being some of the most important. All of the relevant information is available from the fund pages that are on this website.

Pricing

The price of a unit in a fund is directly linked to the net asset value (NAV) of the underlying holdings. Most are priced once a day with all the buying and selling being transacted at that point.

Investment trust shares are traded continuously on the LSE, with the price being driven by the supply and demand according to the prevailing investor sentiment. The NAV, which is published on a regular basis, will obviously play a key role, but there is no direct linkage between the two.

This means that investment trusts can trade at either a discount or premium, which creates both a risk and an opportunity. A case in point is the infrastructure specialist International Public Partnerships − one of Tom Stevenson’s fund picks for 2025 − where the shares are currently available 25% below NAV.

Gearing

Open-ended funds are not permitted to borrow money to invest, whereas investment trusts can as long as their mandate allows. In a rising market this can increase or gear up the underlying returns, although it can also result in bigger losses when the portfolio loses value.

An interesting example is the Foresight Solar Fund, an investment trust that owns a portfolio of solar farms. Like many of its peers it has been struggling and the shares have slipped to a wide discount of 32%.

One of the reasons why investors might be getting nervous is the high gearing, with the debt representing 39% of the gross asset value¹. The management team is currently looking to sell its Australian portfolio to generate some much needed capital.

Income

Funds are required to distribute all of their annual income to the unit holders, whereas investment trusts have the scope to set aside up to 15% in their revenue reserves. This could result in a lower distribution in any given year, but gives them the ability to build up a safety net that might allow them to smoothly grow the income over time.

The best example of this are the Association of Investment Companies’ dividend heroes, which have successfully increased their annual dividends for at least 20 consecutive years. A case in point is the City of London Investment Trust that regularly features in Fidelity’s list of best-sellers.

Longstanding manager Job Curtis mostly invests in large dividend-paying companies listed in the UK. His prudent approach has enabled the trust to increase its annual distributions in each of the last 58 years² and it now offers an attractive yield of just under 5%. Please note this yield is not guaranteed.

Investment cap

UCITs (Undertakings for the Collective Investment in Transferable Securities) funds are not allowed to invest more than 5% in any one security³, although there is a bit of leeway to raise the 5% to 10% as long as holdings between 5.1% and 10% don’t exceed 40% in total. Other types of assets such as government bonds and funds have different limits.

There is no such universal constraint on investment trusts, with the restrictions being governed by their respective mandates. This can make a huge difference to the risk and the potential returns.

One of the most extreme examples is Manchester & London, which has built up a strong track record thanks to its holdings in tech stocks. At the end of January it had 36% invested in chipmaker Nvidia and a further 25.5% in Microsoft.⁴

Source:

¹ Peel Hunt, data as at 31 December 2024
² AIC, February 2025
³ Transferrable securities or approved money-market instruments, The Investment Association, Member Guidance, 2017
⁴ Source: Manchester & London factsheet, January 2025

Important information - Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Eligibility to invest in an ISA or SIPP and tax treatment depends on personal circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). Past performance is not a reliable indicator of future returns. International Public Partnerships Limited (INPP), City of London and Manchester & London Investment Trusts invest in overseas markets so the value of investments could be affected by changes in currency exchange rates. Shares in investment trusts are listed on the London Stock Exchange and their price is affected by supply and demand. Investment trusts can gain additional exposure to the market, known as gearing, potentially increasing volatility. The Key Investor Information Document (KIID) / Key Information Document (KID) for Fidelity and non-Fidelity funds is available in English and can be obtained from our website at www.fidelity.co.uk. Please note that Tom’s picks and Select 50 are not a personal recommendation for you. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.