A unit trust is simply a basket of shares chosen by a fund manager. Imagine the simplest possible unit trust - one that owns just two shares, let's say BP and Shell. If you buy a "unit," the manager buys a share in each company, which then belong to you. If you sell your unit, he sells both shares and hands you the proceeds. The shares are bought and sold at the price prevailing in the stock market, and the unit price is simply the share prices of BP and Shell combined. There is no scope for the unit to trade at a discount to the sum of the share prices of the component stocks. The other type of fund, an investment trust, is a different animal. It is a company in its own right and shares in the trust itself are listed on the stock market. The price of those shares fluctuates like any other share price, and can diverge from the value of the shares owned by the trust. If the share price of the investment trust is higher than the value of the underlying shares, they are said to trade at a premium. When the trust share price is below the value of the assets, the trust is trading at a discount. Discounts of 20pc are not uncommon - even on highly regarded trusts. Click here for a guide on investment trusts If you buy shares in an investment trust when they are trading at a discount, you are buying the underlying shares at less than their value on the market. This may sound like a straightforward bargain but it happens surprisingly often - currently 204 of the 275 trusts on the London stock market are trading at a discount - and it is not an unambiguous signal to buy the shares, experts caution. There is, after all, no way for an owner of shares in an investment trust to realise the value of the underlying assets bought at a discount. He or she can make a profit only by selling the shares later at a better price. But there can be no guarantee that the discount will disappear - it could even get bigger. And even if the discount did shrink, a fall in the value of the underlying shares could cancel it out. The lesson for investors is to buy an investment trust on the basis of the abilities of the manager, not the size of the discount. "First look at how the trust is run and what it invests in, then look at the discount," said Alan Brierley, who analyses investment trusts for Canaccord Genuity, the stockbroker. Investment trusts can offer other advantages over unit trusts, which have to sell assets when an investor wants his or her money back, so they are less suitable for types of investment that are hard to sell quickly. They are fine for blue-chip shares, say, because there are always buyers in the market, but less so for property or other financial assets such as unlisted shares. When you cash in a holding in an investment trust, by contrast, you sell your shares to a new buyer, not back to the issuer, so the fund manager does not have to sell any assets. This has the extra benefit of cutting the fund manager's costs. A unit trust manager is trading in the underlying assets all the time as investors buy and cash in their units. Investment trust managers sell only when they want to make changes to their portfolios. Over time, seemingly small differences in costs can make a big difference to returns, so investment trusts" lower charges can lead to outperformance. This can be seen when the same manager runs both types of fund - a common occurrence. Mr Brierley said: "We looked at the five-year performance records of investment trusts where there was a directly comparable unit trust with a similar investment objective, portfolio and, in almost all cases, the same manager. Investment trusts outperformed in 18 out of 19 cases, and the average outperformance was an annualised 2.24pc. Investment trusts have two other unique features: they can borrow - potentially boosting your returns in the same way that house buyers can make big gains relative to their deposit if house prices rise - and they can hold back some of the dividends they receive in good years to smooth out the income paid to investors. Mike Kerley is one fund manager who runs both types of fund - Henderson Far East Income, an investment trust, and Henderson's Asian Dividend Income unit trust. Mr Kerley, who manages the two portfolios identically, said: "Investment trusts are easier to manage, with the potential to outperform open-ended due to lower transaction costs and the ability to borrow. The structure best suits less liquid underlying investments and markets which are prone to volatile changes in sentiment. They also suit income investors who rely on the certainty of dividend distribution. He pointed out the value of an independent board of directors sitting between the shareholders and the manager of an investment trust, which improves governance. Want more investment tips? Sign up to our weekly newsletter