Giving small investor chance of big rewards

As a 'collective' savings vehicle, the money from all investors is pooled which means the risks are shared. It also allows for a far wider spread of investments than an individual can hope to hold personally.

The concept of an investment trust was devised by a solicitor, Philip Rose, who co-founded the law firm Norton Rose. In March 1861 the first such trust, Foreign & Colonial, was founded – the same year as the University of California was founded, helium discovered and first Trades Union Congress held.

Then, as now, the aim was to "give the investor of moderate means the same advantages as the large capitalists in diminishing the risk of...investment".

F&C originally invested in government bonds from such countries as Brazil, Chile, New Zealand, Russia, Turkey and the US and only purchased its first equity (Shell) in 1925.

Collective funds may be broadly divided into two groups: closed-ended (such as investment trusts) or open (like unit trusts). 'Closed' means a fixed number of shares whilst 'open' allows for unlimited inflows of money and units to be created.

Stockbrokers Charles Stanley have compared them in key sectors, concluding that closed ones are superior for:

n better performance, such as up 49 per cent for global growth (35.2 per cent open), 61.8 per cent for Europe (but 49.2 for open) and 198.8 per cent for global emerging (132.8 per cent open), all over five years;

n higher yield, such as 5.2 per cent for UK Income and Growth (but 3.9 per cent for open), 2.4 per cent for UK Smaller Companies (but only 0.8 per cent for open) and 3.4 per cent for Japan (but an appalling 0.4 per cent for open);

n lower fees, such as only one per cent total expenses for UK Income and Growth (but 1.8 per cent for open), one per cent for continental Europe (but 1.7 per cent for open) and 0.9 per cent for global emerging markets (double such fees for open).

These are average statistics and clearly there are better and worse performers in both types of saving. Close-ended trusts are listed on a stock exchange and therefore raise money by issuing shares. Usually this happens once when a company is created. They are 'close-ended' as the number of shares is set and hence the amount of money raised is fixed from the start.

Each investment trust company has a board of directors which meets several times a year and monitors performance. It has a legal duty to uphold the interests of shareholders and decides who will be the trust's managers. Unlike unit trusts, investment trusts can borrow to purchase additional investments, known as 'gearing'. It allows such collectives to take advantage of a long-term view on a sector or gain a favourable situation without having to sell existing stocks.

The idea is to make a high enough return on the new investment to cover the borrowing cost and make a profit. The higher the borrowing, the greater the risk – but the higher the potential returns.

The share price of an investment trust is determined by the stock market. It often differs from the underlying net asset value (NAV) with the difference known as a discount or premium.

If the NAV is 100p and share price 90p, then the discount is 10 per cent.

By comparison, the prices of unit trusts and open-ended investment companies (OEICs) are calculated on the value of their assets so they can never be purchased at a discount to NAV.

Choosing the right investment trusts depends on many factors, such as whether you want:

regular income;

money to grow for several years;

combination of income and capital growth;

more or less risk with greater potential for success or failure.

Neither profit nor income is guaranteed and the end return may be less than invested. You may favour a specific geographical or industry sector.

There are 307 investment trusts with 87.5m assets of whom about half are private shareholders. According to the AIC using Morningstar research, over five years to the end of May, the top sector performers on a net basis (after typically 3.5 per cent expenses have been taken into account), have turned 100 into:

UK growth: Hansa Trust 148.81;

UK growth & income: Edinburgh Investment 139.02;

Global growth: Gartmore Global 196.10;

Global growth & income: Murray International 206.31;

Global emerging markets: Templeton Emerging Markets 302.96;

Asia Pacific (excl Japan): Scottish Oriental Smaller Companies 236.10;

Europe: Gartmore European 157.48.

Smaller companies also performed well with top performing Standard Life in the UK with 214.40 and F&C US in North America with 148.88.

Few trusts specialise in Australasia, North America or Latin America or sectors like health or utilities.

Currently Martin Payne of Leeds stockbrokers Brewin Dolphin likes Temple Bar as a UK focused income and growth trust, predominantly investing in 'blue chip' equities and offering an income yield over four per cent annually. He said: "The trust has a good track record with unbroken increases in income distribution for 25 years with an annual management charge of just 0.35 per cent."

Payne also tips both Standard Life UK Smaller Companies, currently trading at a 10 per cent discount, and Templeton Emerging Markets. Payne likes the latter manager's approach to focusing on individual companies rather than country weightings.

For those seeking property exposure, don't forget REITS, which enjoy special tax breaks and can therefore offer high distribution yields. Payne likes both British Land and Hammerson.

Jonathan Baker at Charles Stanley tips Scottish Mortgage for global growth. Founded in 1909 originally to invest in rubber plantation companies in Malaysia, it has successfully diversified and is focused on long term growth. He also likes Aberdeen's Asian Smaller Companies, which looks for firms with strong franchises, steady growth potential and good management.

If investing out of income or preferring the advantages of 'drip feeding' money in rather than selecting just one date for a lump sum investment, many trusts offer regular savings schemes. For children's savings, schemes start at 25 (such as F&C, SVM and Witan) and for pension plans at 50 (Alliance, F&C and Graphite Capital through F&C).

Many investment trust managers also offer ISA wrapper arrangements which start from just 10 (M&G on 0800 390390).