Open almost any investment platform and you will be offered two ways to buy the same idea. You want exposure to global shares, or UK smaller companies, or infrastructure. You can get it with an exchange-traded fund or with an investment trust. Both list on the London Stock Exchange, both trade like shares, and both show a price on a screen. The differences underneath — how they are built, what they charge, and how their market price relates to the value of what they hold — matter more than most marketing suggests.
Two structures, one decision
An ETF is an open-ended fund. It trades on an exchange, but the number of shares can grow or shrink as money moves in and out. Market makers create new shares when demand rises and cancel them when it falls, which keeps the traded price tethered closely to the value of the underlying holdings. Most ETFs bought by UK investors are domiciled in Ireland or Luxembourg and physically hold the shares they track.
An investment trust is closed-ended. It is a company listed on the exchange with a fixed number of shares. Managers cannot issue new shares every time you want to buy, so the share price is set by supply and demand from investors. That creates the feature ETFs largely avoid: the price can sit above the net asset value of the portfolio (a premium) or below it (a discount).
Trusts also have an independent board, which can borrow against the portfolio and buy back shares. Ordinary ETFs do neither.
Costs: the obvious and the hidden
Compare ongoing charges first, and ETFs usually win. Broad index ETFs are cheap to run and often cost a fraction of an active trust's annual charge, because most simply track a benchmark.
Then look at what the headline figure leaves out:
- Dealing costs. Both charge commission when you buy or sell, though many platforms now offer a set of commission-free ETFs. Frequent small trades can wipe out the benefit of a low annual fee.
- The spread. The gap between the buy and sell price. A large, liquid ETF might have a spread of a fraction of a percent; a thinly traded trust can be far wider.
- Stamp duty. Buying shares in a UK-incorporated company — which includes most investment trusts — generally attracts stamp duty of 0.5%. Most ETFs are domiciled outside the UK, so a purchase normally does not. Tax rules change, so check your own position with an adviser.
- Platform fees. Some charge a percentage of everything you hold, which bites hardest when returns are modest.
Trading and pricing: the bit that catches people out
Both trade during the day, which is already a step up from a traditional unit trust that prices once daily.
With an ETF, your order fills at whatever the market is quoting, and that quote is kept honest by the creation and redemption process. With a trust, you are trading with other investors. If sellers outnumber buyers on a bad day, the discount widens and you feel it.
Three habits that help
- Use limit orders rather than market orders, so you name your price.
- Avoid the first and last fifteen minutes of the trading day, when spreads are typically widest.
- Before buying a trust, check its current premium or discount and how it has moved over several years. The Association of Investment Companies publishes this data for its members, and trust fact sheets usually show a chart. Buying at a 9% premium when the trust has averaged a 2% discount is a poor start, whatever the portfolio holds.
Gearing, income and the discount
Gearing is the clearest structural difference. A trust can borrow to invest more than its shareholders' money. In a rising market that amplifies returns; in a falling one it amplifies losses, and the debt still needs servicing.
Trusts can also hold back income in strong years and pay it out in weaker ones. That revenue reserve is a real advantage if you are drawing an income, and it is one reason these structures have loyal followings among retirees. Many boards buy back shares when a discount stretches too far, which supports the price.
An ETF cannot do any of that. Its job is to track. Leveraged and inverse ETFs exist, but they reset daily and behave very differently — they are trading tools, not long-term holdings.
Typical use cases
- Core exposure to global or US shares: an ETF. Cheap, liquid, no gearing, no discount to monitor.
- A regular monthly investment: check dealing charges first. A commission-free ETF with a tight spread may beat a trust once stamp duty is added in.
- Niches where indexes are thin: smaller companies, specialist property, renewable infrastructure, private equity. Investment trusts are often the most practical route.
- Income in retirement: trusts with long dividend records and revenue reserves deserve a look, alongside the fees and gearing.
- One-fund portfolios: multi-asset trusts can work neatly, though compare the ongoing charge with a simple mix of two or three ETFs.
A practical starting point
Write down what the money is for and how long you will leave it invested. If it is a long-term core holding and you want low cost and predictable pricing, an index ETF is usually the sensible default. If you want a manager making decisions, an income stream that has been buffered, or access to a market where ETFs are scarce, an investment trust earns its place — provided you buy near or below net asset value.
Then do three things before you deal. Check the total cost, including the spread and any stamp duty. Compare the fund's fee against its closest rival in the other structure. And read the latest annual report, or at least the summary on the trust's own website, so you know exactly what you own.
None of this replaces advice tailored to your circumstances. If you are unsure how these fit your tax position or your plans, speak to a regulated financial adviser. The above is general information, not a personal recommendation.
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