Big can be beautiful if you are a small saver

When trying to avoid taking too much risk, large investors buy shares in a wide spread of companies, often across a broad spread of countries as well. An ideal way for small investors to invest in the same way is to use investment trusts.

Over the years, investment trusts have done exceptionally well for investors. Over the past decade they have even done better than pension funds, which are exempt from tax. Investment trusts manage over pounds 45bn of assets for shareholders and are becoming an increasingly popular form of saving.

Investment trusts were first set up over a century ago to allow private investors to take a stake in the building of the American railroads. Today there are over 300 investment trusts providing everything from low-risk international general portfolios to higher-risk single-country emerging market trusts such as China and India. In between are UK specialist, high income and industrial specialist trusts.

They are public companies listed on the London Stock Exchange This means that it is always possible to buy and sell a holding. It also means they are regulated both by company law and the Stock Exchange and have a board of independent non-executive directors whose sole responsibility is to look after shareholders' interests.

Investment trusts are closed funds. Once they have raised their initial capital from investors, the pool of money available to the fund manager does not generally vary. This means that, unlike a unit trust manager, the investment trust fund manager is never forced to sell his or her best quality shares into a falling market to raise the cash to pay investors who are selling.

Another significant advantage is that investment trusts are allowed to borrow to increase the returns they can deliver to shareholders. This is not an option open to any other form of collective investment available to the small investor. History has shown that equities should provide better returns than cash over the longer term, so borrowing at the right time and interest rate will improve the total returns available.

Thanks to their closed nature, investment trusts spend less on marketing than other pooled investments. This means that their average charges are typically much lower than comparable unit trusts - a 0. 6 per cent annual charge and 1.5 per cent buying costs against the typical 1.25 per cent annual charges and 6 per cent buying costs for unit trusts. This means that if an investment trust and a unit trust were to produce identical investment returns, the investment trust would deliver better performance to the investor because of lower charges.

The final key characteristic of investment trusts is that they can trade at a premium or a discount to their net asset value. This may sound complicated but it is really just a re-statement of the law of supply and demand. If more people want to sell shares than there are willing buyers, prices fall and vice versa. This means the share price of an investment trust can often stand below the level justified by the value of the assets held.

For historical reasons, most investment trusts fell to large discounts by the1970s. Over the past 15 years, these have narrowed considerably. This means buyers have benefited not only from the general performance but also from the increase caused by narrowing discounts. The average discount on investment trusts which are members of the Association of Investment Trust Companies is 8 per cent.

So investors should look for trusts with strong managements investing in an area with good prospects. If the share price stands at a reasonable discount to net asset value the trust is even more attractive.

Finally, don't forget that investment trusts are allowed for a general PEP. This means that any investment trust with more than half of its assets in the European Union can be put into a PEP up to the full pounds 6,000 annual limit and enjoy freedom from income and capital gains taxes.

Had you invested pounds 1,000 in the average UK investment trust over 15 years to 30 June 30 this year it would have returned pounds 11,800 compared with pounds 8,468 for the average UK unit trust and pounds 2,242 to beat the retail price index. Anyone investing the maximum allowance in the average PEP-able investment trust since 1989 would have accumulated pounds 50,483 by 30 June this year for a total investment of pounds 35,400.

Investment trust PEPs have also knocked tax-exempt special savings accounts - Tessas - into a cocked hat. If you had invested the same amount in the average PEP-able investment trust as you could have put into a Tessa each year on 3I December since 1990, you would have invested pounds 9,000, but the investment trust would have been worth pounds 13,658 by 3I December 1994 compared with pounds I0,728 in a Halifax Tessa, according to the AITC.

The author is marketing director of Flemings Investment Trust Management.

Fifteen-year performance

Initial value pounds 100, net income reinvested

Fund Cash Fund size (pounds m)

Alliance pounds 1,468.86 949.54

Anglo & Overseas pounds 1,298.86 501.39

Bankers Trust pounds 1,934.40 302.49

British Assets pounds 802.67 283.85

Fleming Japanese pounds 1,527.89 356.20

Foreign & Colonial pounds 1,575.98 1,460.96

Govett Oriental pounds 1,651.19 621.76

Murray International pounds 1,459.76 409.91

Scottish Mortgage Trust pounds 1,470.42 844.08

Witan pounds 1,406.75 881.96

Source: Micropal