Investment trusts are the grandaddy of the fund world. The first, Foreign & Colonial, which is still going strong today, was formed in 1868 to give smaller investors access to the world's stock markets.

The idea quickly caught on and investment trusts played a vital role in funding the 19th-century expansion of America's railways.

There are now more than 440 investment trusts managing £97 billion of assets. Yet compared with unit trusts and Oeics (open-ended investment companies) they remain relatively unknown and little understood. But if you are keen to find out more, read on.

What is an investment trust?

A public company traded on the London Stock Exchange that invests in other companies' shares. Like any other company, they issue shares to raise money from shareholders. They then invest that money in a broad range of assets, including shares, bonds and property.

Some invest only in the UK, others overseas. Because investment trusts are companies, they have boards of directors and are also able to borrow money to invest.

How do they work?

An investment trust's share price depends not only on the value of the assets in which it has invested - its net asset value (NAV) - but also on the demand for its shares. If more people want to buy than sell, this drives up the share price.

When the market price of the trust’s shares is less than its NAV, it is said to be at a discount. If its share price is higher than the underlying stock market value of the trust, it is at a premium.

The discount is one of the main advantages of investment trusts, say supporters, because it offers canny investors the chance to make extra profits. If you buy a trust when the discount is wide and sell when it narrows, you will boost your returns. Of course, you lose out if you get it wrong, which is why others say that the discount makes investment trusts riskier.

Discounts and premiums are quoted daily in The Times and share prices are available online.

What are Reits?

Real-estate investment trusts (Reits) are a special type of fund introduced by the Government in January 2007 to make it more tax-efficient for investors to hold property in their portfolios. They pool investors' assets in a portfolio of properties, usually shops, offices and warehouses. Eventually, there may be also Reits invested in residential property.

Investors are able to reclaim tax that they would normally pay on dividends if they invest in a Reit via a pension or an Isa. Furthermore, the company does not have to pay tax on its profits, so a higher portion of its earnings can be distributed to shareholders.

Where can you buy investment trusts and Reits?

You buy the shares in the same way as you would a normal company, by contacting a stockbroker. Alternatively, you can approach the fund management group that runs the scheme. Most of the larger investment trusts allow you to invest regular amounts or lump sums via an Isa. The Association of Investment Companies website has more information.

Are they expensive to buy?

There is no initial charge, but you will pay a stockbroker's commission on buying and selling. Provided that you use a low-cost broker, the charges will be relatively small. You have to pay stamp duty of 0.5 per cent on purchases and there will also be an annual management fee, but overall charges tend to be lower than those on unit trusts.

How else do they differ from unit trusts?

Investment trusts can borrow money to buy more shares, while unit trusts cannot. This borrowing is often referred to as "gearing" and can help a trust to make money more quickly in a rising market.

However, gearing can be a curse in a falling market because it magnifies a trust's losses. Not all trusts use gearing and for those that do, the manager will be able to borrow only if the trust’s board of directors agrees.

Why aren't they more popular?

One reason is that they do not pay commission to financial advisers, who tend to push investors in the direction of unit trusts, which do. However, you can find an adviser who is happy to recommend investment trusts by using the Unbiased website run by IFA Promotion.

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