INVESTMENT trusts have been around since the 1860s whereas unit trusts did not become popular until the 1960s.

In essence the former are companies that hold investments and whose shares trade on the stock market. They have both advantages and disadvantages from an investor’s perspective.

One of the main advantages is that, because trusts are exchange traded, their managers do not have to worry about the liquidity of the underlying investments.

They can take a longer-term view safe in the knowledge that, unlike with a unit trust, investors cannot demand their money back at short notice.

Accordingly investment trusts often have an advantage where the underlying investment is less liquid, like property or smaller companies, meaning they do not need to keep a cash reserve that might drag on performance to meet redemptions.

A knock-on advantage is that trading tends to be less active and this helps to explain why management costs are generally lower than for an equivalent unit trust.

However, a possible disadvantage is that the managers may be less incentivised to perform well as, unless they perform really poorly, they are unlikely to see funds withdrawn.

Consequently, they may devote fewer resources to the management of the trust, especially if they have other funds to manage that are more at risk of losing money or have the potential to attract money.

A second significant advantage is that investment trusts can borrow money - known as gearing - to enhance returns. Returns will be enhanced if portfolio returns exceed borrowing costs and vice versa, so a good manager will borrow at the bottom of the market and repay the borrowings nearer the top.

Investment trusts can smooth income payments as they do not have to pay out all the income received in the boom years but can build up reserves to maintain a steady, hopefully growing, income stream.

A further advantage is that you can deal in investment trusts at any point in the trading day to take advantage of short-term fluctuations and you know the price you are dealing at. However, in times of crisis, when you might want to trade, the liquidity can dry up.

Do not forget the cost of the stockbroker’s commission either. Investment trusts are traded like conventional shares and will therefore typically incur trading costs and stamp duty on purchases.

So far so good. However, investment trusts have their drawbacks. For example, due to supply and demand, their share prices may not track the value of the underlying portfolio for significant periods. Many trusts suffer from low demand because they are too small to attract institutional investors.

Certain sectors may also be out of favour, such as property, which until recently had tended to trade on a premium because there was little cash drag. If a star investment manager leaves, the trust they ran may also suffer a sudden drop in value.

Conversely, they may benefit from a takeover or shareholder activity if they are performing poorly. Overall this results in amplified gains and losses.

Discounts on investment trusts tend to narrow in a rising market and widen in a falling one, amplifying the effect of the change in the value of the underlying portfolio. This is a similar effect to that of gearing and has the effect of making an investment trust more volatile than an equivalent unit trust.

In recent years the managers of investment trusts have been more active in managing discounts and often have in place schemes to buy back shares if the discount widens too far. Conversely, if an investment trust is trading on a premium they can sell more shares into the market to meet the demand and help dampen volatility.

There are many moving parts to consider with an investment trust over and above the movement of the underlying holdings so they require a higher level of attention than unit trusts to get the best out of them.

David Thomson is chief investment officer at VWM Wealth.