Investment trusts have been unsung heroes for many years, overshadowed by their much larger rivals in the unit trust sector.

While investors have a massive £468 billion stashed away in unit trusts, they have only a modest £72 billion in investment trusts. Yet this latter, often overlooked, sector boasts a good track record.

Investment trusts are collective investments, like unit trusts and open-ended investment companies (Oeics), that pool investors' money and put it in the stock market. Although all of these perform the same basic function, investment trusts operate in quite different ways.

Investment trusts have a fixed number of shares and their price is determined by supply and demand for them. Unit trusts, meanwhile, can issue new units and the price exactly reflects the underlying value of the fund. This method of pricing is easier to understand and the complexity of investment trusts is undoubtedly one of their drawbacks.

However, if investors can overcome the hurdle of understanding investment trusts, they do have significant attractions. First, they tend to have lower charges than unit trusts. Lipper Fitzrovia, the fund research company, has looked at the total expense ratios (TERs) - covering annual management charges

and other costs, such as administration and audit fees - for both sectors. Ed Moisson, of Lipper Fitzrovia, says: “For unit trusts and Oeics the TERs averaged 1.62 per cent a year. For investment trusts the average TER was significantly lower, at 0.95 per cent.”

These lower charges have also helped investment trusts to produce good performance. A comparison of the unit trust global growth sector and its investment trust global growth counterpart, shows that, over ten years, the unit trusts produced an average return of 48.4 per cent, against 90.7 per cent for investment trusts. This was no flash in the pan: investment trusts were also better performers over both three and five years.

But there are even more direct comparisons to be made. Some investment houses, such as Fidelity, run pairs of almost identical portfolios; one as an investment trust and the other as a unit trust, or Oeic. The Fidelity Special Situations Oeic, one of the unit trust industry's best long-term performers, has produced a ten-year return of 237 per cent. But its investment trust counterpart, Fidelity Special Values, with a virtually identical portfolio and run by the same managers, Anthony Bolton and now Sanjeev Shah, has produced a higher return of 272 per cent. Yet, while the better-performing trust is worth only £293 million, Special Situations weighs in at £2.9 billion.

John Newlands, of Brewin Dolphin, the stockbroker, adds: “Investment trusts, unlike unit trusts, have their own independent board of directors, who are there to represent shareholders' interests. Investment trusts also have to hold an annual general meeting at which shareholders can turn up and meet the directors and managers face to face.”

So why are investment trusts so often ignored in favour of frequently poorer-performing unit trusts? The former tend to suffer from being less heavily promoted than unit trusts, in addition to being generally more complex products.

To start with, investment trusts have to be bought and sold through a stockbroker, which means paying brokers' fees on buying and selling, plus stamp duty of 0.5 per cent on purchases. This deters a lot of people, though many investment trust groups now offer their own savings plans to look after the dealing side at reduced or zero cost.

Another factor that investors often have difficulty understanding is the pricing mechanism. While a unit trust's price exactly reflects the net asset value (NAV) of the underlying shares, an investment trust's share price is determined by supply and demand, so can be either higher or lower than its NAV. This is known as trading at a premium, or a discount, to NAV and can confuse investors. The simplest way to get to grips with this is to realise that most trusts trade at a discount most of the time.

A further complication is the question of gearing. Most investment trusts “gear up”; that is they borrow money to buy more shares. This, again, is potentially confusing but, essentially, gearing will boost a trust's performance on the way up and speed its fall on the way down. However, Roddy Kohn, of Kohn Cougar, the independent financial adviser, points out: “Stock markets go up more often than they go down. Therefore, on balance, gearing tends to be a positive factor.”

The lower charges on investment trusts mean that there is less in the kitty for marketing campaigns, so they cannot sell themselves as heavily as unit trusts. Their leaner charges also mean that they do not always pay commission to financial advisers, who may be less inclined to recommend a product that pays them nothing.

But as Mr Newlands points out: “It is worth making the effort to understand how investment trusts work. They have long been regarded as the City's best-kept secret and many high-net-worth investors use them as their collective fund of choice.”

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