Reader's question on investment trusts for grandchildren

I want to invest a modest monthly sum for my two grandchildren aged seven and three years old, with a view to helping them with college fees when the time comes. What are the relative merits of using unit trusts and investment trusts to achieve this?

The company I deal with only mention unit trusts in their promotional material, although they say it is possible to purchase investment trusts through them. Do they concentrate on unit trusts because there is more commission for them, or are there good reasons for favouring this type of investment?
P McPherson, Leeds

Paul Duckworth replies:

Assuming you will be looking to invest until your grandchildren are, say, 18 or 21 years old, either share-backed unit trusts or investment trusts should produce a good return – not without some fluctuations on the way, though.

Also, as a grandparent you should not be caught out by the income tax consequences or mooted capital gains tax consequences of parents saving for children. These payments may actually fall into your inheritance tax (IHT) allowance, making them IHT free.

Share-backed unit trusts and investment trusts should offer broadly similar investment characteristics. However, some crude comparisons between the two would be:

• Investment trusts are potentially more volatile because, being closed-ended and traded on the stock exchange, the share price can trade at a premium or, more likely, a discount to the net asset value. The share price will fluctuate as they move in and out of favour.

• In theory, if you buy an investment trust at a discount, you get an income stream magnified by the discount factor.

• Unit trusts are generally easier to buy, especially using small, regular contributions. They are also available through fund supermarkets, such as Fidelity FundsNetwork, Skandia and Cofunds. Investment trusts are generally not. Using fund supermarkets opens the possibility of using several funds from different investment houses, fund diversification, asset allocation, low-cost switching and so on.

• Some investment trust companies do run their own regular contribution schemes but you would normally have to go direct to that company.

• Unit trusts usually pay the adviser commission. Investment trusts normally do not.