An investment trust is a way in which multiple investors can pool their money for mutual investment. The precise definition and set-up of an investment trust varies slightly from country to country. The general principle is that the investment trust is legally considered a company in itself, and that investors are buying a share in the company and then receiving a share in the profits it makes from its investments. This can have tax advantages: for example, in the United Kingdom, the investor pays tax on his share of the profits, but does not pay tax on any profit he makes if and when he sells the share in the trust.
There are multiple variations on the basic investment trust. A version in the United States, known as a unit investment trust, or UIT, works in a similar legal fashion in that the trust is considered a company itself. The main difference is that a unit investment trust exists only for a predetermined period and only makes one set of investments rather than buying and selling. This means that once active, the trust does not need an investment manager.
At the end of the set period, the trust is liquidated in a way that returns investors' money, plus or minus any profits or losses from the investment. The investors then only pay taxes based on any profits during the lifespan of the trust. This is in contrast to a mutual fund where taxes are based on the performance of the fund's investments during the entire year, regardless of when the individual investor bought into the fund. This creates the possibility that the investor could make a loss and then be taxed based on the fund's full-year profits.
One variation on the UIT is the split capital investment trust. This allows investors to choose between two or more forms of share in the trust. The money paid out by the trust at the end of the set period is allocated in a particular order, meaning investors with a particular type of share are more likely to get paid, while there may be no money left for payout to investors with another type of share.
This varying risk is reflected in two ways. Firstly, those with the most secure type of share may not be eligible to receive a portion of any dividends that the trust receives from its investments. Secondly, the purchase price for the riskier types of share will usually be lower.
