A Unit Investment Trust (UIT) is an open-ended pooled fund consisting of securities held in it for a specific time.  The sponsoring trust entity carefully and strategically chooses the stocks and bonds that would make up the portfolio.

Generally, the UIT’s sponsor does not actively trade the securities but just buy and retain for their returns. Usually, a unit investment trust has an SEC registration as a Registered Investment Company (RIC) or Grantor trust.

Most often, the portfolio stays fixed until the sponsor terminates the trust. This can take anywhere from 13 years to 30 years, depending on the underlying securities.  There might be instances when the sponsor may remove security or two from the trust.

However, they will only do it under limited circumstances, usually to protect the fund.  An investor may find these situations in the prospectus or Declaration of Trust.

What is Unit Investment Trust (UIT)?

The UIT follows a financial game plan.  It is an investment objective over a specific time period.  However, there is no guarantee that the sponsor will meet this objective.  The trust sponsor creates the trust by laying down the specific investment terms.  They include the trust objective, securities to put into the trust, the period of the trust, schedule of fees, etc.  Investors will find these terms in the prospectus.

Some UITs stick to popular rules when choosing the stocks for the portfolio.  They choose the securities through a method called ‘back-testing’.  It’s a method of applying an investment strategy over a mix of stocks and bonds.  The objective is to see the result if the mix was done years before.

How It Works

The hypothetical performance can help investors by showing how the strategy will work at the present time. It is wise to remember that past success does not guarantee future success.  The hypothetical performance relies on past performance and the future will always change.

A unit investment trust is technically an investment company. Its fixed portfolio of stocks and bonds become redeemable units to investors over a specific time period.  The objective is to increase the capital’s value and/or earn through dividends.  Aside from UIT’s, regulators also consider mutual funds and closed-end funds as investment companies.

Types of Unit Investment Trusts

The securities in a UIT determine what type of trust it is. They may be a stock (equity) trust or a bond (fixed-income) trust.

Stock Trusts

Stock trusts generally provide capital appreciation or income from dividends.

Sponsors usually issue as many units or shares as needed for a limited time before the primary offering period ends. Equity trusts have a definite termination date.  On this date, the sponsor liquidates the trust and distributes the proceeds to unit holders.  They will use the net asset value as the basis for distribution. The unit holders may choose to receive the money and spend it, as they will.  They can also opt to reinvest the proceeds in another UIT.

Bond Trusts

In a bond trust, the sponsor issues a fixed number of units.

When they sell all the units to investors, they then close the primary offering period.  Bond trusts will pay a relatively fixed monthly income to unit holders.  This will happen until the first bond matures (or ‘called’ by the bond’s issuer). The sponsor will then distribute the proceeds to the investors upon the redemption of the bond.  This is actually a return of principal and the sponsor will allocate the funds pro-rata, according to investors’ principal.

The trust will continue to pay the adjusted monthly income until the next bond reaches its maturity.  The pattern will go on until the sponsor redeems all the bonds in the portfolio. As you can see, for people who want current income and a stable principal, a bond trust is ideal.

Strong Growth

In recent years, UITs have grown in popularity due to many reasons.  One of them is that most of them have primary investment objectives geared towards providing dividend income.

The UITs can select their portfolios to include securities that provide better returns than traditional securities like bonds. These income-producing securities can include the following:

Features of a Unit Investment Trusts

A UIT will have a sponsor for a fund manager. It does not have a board of directors, corporate officers or investment advisers to provide financial advice during its term.

The UIT can distribute interests and dividends to its investors.  When the life of the trust ends, investors can receive cash equal to the net asset value of their units.  In some cases, they can receive the payment in kind from the investments held by the trust.  They can also opt to roll the current value of their units into another trust fund usually at discounted charges.

UITS have a pre-determined fixed term.  For trusts that invest in equities, the life range is an average of two years.

UITs Vs Mutual Funds

From many angles, UITs and Mutual Funds look very similar.  But when you look closely, there are many distinct differences.  Yes, they both have professionally-selected securities in their portfolios.  However, UITs maintain a fixed portfolio, not like mutual funds. The sponsors don’t normally change any of the stocks and bonds once they select them.

Since these securities remain the same throughout the term, investors can see what they really own. Investors can usually buy or sell UITs on any business day at the current market price.  This price could be greater or lesser than what the investors originally paid for them.

In mutual funds, the fund manager actively trades the securities in the hope of generating more income for the fund. In a UIT, the fund manager selects, buys and holds the securities until maturity.

Buying a UIT is quite different from buying a mutual fund.  The management fees of a UIT are lower than the fees for a mutual fund.  In a buy-and-hold scheme like in a UIT, there’s not too much ‘management’ involved.  There are sales fees attached to UITs. Mutual funds also carry similar fees.

Here’s the difference:  investors pay a sales commission to buy a UIT, but not when you sell.

The sponsor of a UIT holds the securities in its portfolio until their maturity dates.  This causes the UITs to adopt the same maturity dates.  Mutual funds do not carry this maturity feature.

Pros and Cons of Unit Investment Trusts

DiversificationPortfolio Managers Cannot Actively Manage The Securities
Professional Portfolio AssemblyInvestors Have To Pay Special Fees
Know Exactly What Yhey Own

Advantages of a UIT

Investors prefer UITs to other funds for several reasons.  These are:

Disadvantages of a UIT

Now, here’s the other side of the coin:

  Unit Investment Trust Tax Impacts

For the taxation-conscious, UITs offer shelter from the unrealized capital gains taxes.

This shelter is not available for mutual funds. Sponsors assemble UITs for a specified time.  Therefore, the purchase price of the securities serves as the cost basis of the units. For a mutual fund, the basis is different. The government will tax the investor for the entire previous year, irrespective of the actual purchase date.

For example:

An investor may purchase a mutual fund in October and absorbs a loss in that quarter. Still, the government will tax the investor for capital gains of the underlying securities from January 1 of the year. A UIT avoids this tax consequence because it assembles a new ‘investment’ for each individual investor.

Several exchange-traded funds are technically UITs. However, ETFs do not normally have set portfolios. The fund manager administers it or updates it to automatically follow an index. It can have a lifetime of up to over 100 years. For example, according to their prospectus, the SPDR S&P 500 ETF Trust has a mandatory termination date of January 21, 2118.[i]  Also from their prospectus, the PowerShares QQQ Trust will terminate on March 4, 2124.[ii]


Leave a Reply

Your email address will not be published.