ETFs and investment trusts

Funds, ETFs and investment trusts all give you a diversified portfolio in one holding. The structural differences change how they price, what they can do, and where each fits.

Exchange traded funds

An ETF is usually a tracker fund that trades on a stock exchange like a share. You buy and sell at a live price during market hours rather than at a single daily valuation point.

Why people use them: typically low ongoing charges, intraday dealing, and very broad choice covering almost any index you can name.

What to check:

Physical or synthetic. Physical ETFs actually own the underlying holdings. Synthetic ones use derivatives to deliver the index return, which introduces counterparty risk. Physical is more straightforward, and most mainstream ETFs are physical.

Tracking difference. How closely it has actually followed the index after costs. More useful than the headline charge on its own.

Domicile. Where the ETF is based affects withholding tax on dividends and, for UK investors, whether it has reporting fund status. A non-reporting fund can have gains taxed as income rather than capital gains, which is a significantly worse outcome.

Size and liquidity. Very small ETFs can close, and thinly traded ones have wider spreads.

Dealing costs. Because they trade like shares, each purchase may attract a dealing commission. That makes ETFs less suitable for small regular monthly contributions on some platforms, where a fund would cost nothing to buy.

Investment trusts

Structurally quite different, and the differences are interesting.

An investment trust is a company listed on the stock exchange whose business is holding investments. You buy shares in that company.

Because it's closed-ended — a fixed number of shares — the share price is set by supply and demand rather than by the value of the underlying assets. So the price can sit below the net asset value (a discount) or above it (a premium).

That creates a genuine opportunity and a genuine risk. Buying at a discount means acquiring assets for less than they're worth. But the discount can widen after you buy, producing a loss even if the underlying investments did fine.

Gearing. Trusts can borrow to invest. This magnifies gains and losses, and it's a real difference in risk compared with an equivalent open-ended fund.

Revenue reserves. A trust can hold back income in good years and use it to maintain dividends in bad ones. This is why some trusts have raised their dividend every year for decades — a consistency no open-ended fund can structurally offer, and the reason income investors often favour them.

No forced selling. Because the capital is fixed, a trust doesn't have to sell holdings to meet redemptions. That makes them better suited to illiquid assets — property, infrastructure, unlisted companies — where open-ended funds have repeatedly run into trouble and suspended dealing.

Which to use where

Regular monthly investing in mainstream markets: funds usually win, because they're free to buy on most platforms and priced at asset value.

Broad, cheap index exposure as a lump sum: ETFs are strong.

Income consistency: investment trusts have a structural advantage through revenue reserves.

Illiquid assets — property, infrastructure, private companies: the closed-ended structure is genuinely better suited.

Simplicity: funds. No discounts to monitor, no gearing, no dealing costs on most platforms.

None of these is a rule. Plenty of sensible portfolios use all three.

This article is for general education only and isn't personal advice or a recommendation of any investment.

Related in this topic

• Funds: unit trusts and OEICs
• Active or passive?
• What you actually pay