A unit investment trust (UIT) is a U.S. investment company that buys and holds a portfolio of stocks, bonds or other securities. UITs share some similarities with two other types of investment companies: open-ended mutual funds and closed-end funds. All three are collective investments in which a large pool of investors combine their assets and entrust them to a professional portfolio manager. Units in the trust are sold to investors, or “unitholders.”
Like open-ended mutual funds, UITs offer professional portfolio selection and a definitive investment objective. They are bought and sold directly from the issuing investment company, just as open-ended funds can be bought and sold directly through fund companies. In some instances, UITs can also be sold in the secondary market.
Like closed-end funds, UITs are issued via an initial public offering (IPO). But if mutual funds are purchased at the IPO, there are no embedded gains to be found. Each investor receives a cost basis that reflects the net asset value (NAV) on the date of purchase, and tax considerations are based on the NAV.
Like open-ended mutual funds, UITs often have low minimum investment requirements.
Open-ended funds, on the other hand, payout dividends and capital gains each year to all shareholders regardless of the date on which the shareholder bought into the fund. This can result, for example, in an investor buying into a fund in November, but owing capital gains tax on gains that were realized in March. Even though the investor didn’t own the fund in March, the tax liability is shared among all investors on a yearly basis.
Unlike either mutual funds or closed-end funds, a UIT has a stated date for termination. This date is often based on the investments held in its portfolio. For example, a portfolio that holds bonds may have a bond ladder consisting of five-, 10- and 20-year bonds. The portfolio would be set to terminate when the 20-year bonds reach maturity. At termination, investors receive their proportionate share of the UIT’s net assets.
While the portfolio is constructed by professional investment managers, it is not actively traded. So after it is created, it remains intact until it is dissolved and assets are returned to investors. Securities are sold or purchased only in response to a change in the underlying investments, such as a corporate merger or bankruptcy.
- A unit investment trust invests for the investor, or unitholder, much in the same way as traditional funds.
- UITs have a predetermined expiration date, making them function like a bond or similar debt security.
- Investors favor bond UITs over stock UITs, simply due to the fact that bond UITs are more predictable and less likely to suffer losses. Stocks are sold in the UIT at expiry, which doesn’t allow the investor to recoup any losses.
There are two types of UITs: stock trusts and bond trusts. Stock trusts conduct IPOs by making shares available during a specific amount of time known as the offering period. Investors’ money is collected during this period, and then shares are issued. Stock trusts generally seek to provide capital appreciation, dividend income or both.
Trusts that seek income may provide monthly, quarterly or semiannual payments. Some UITs invest in domestic stocks, some invest in international stocks and some invest in both.
Bond UITs have historically been more popular than stock UITs. Investors seeking steady, predictable sources of income often purchase bond UITs. Payments continue until the bonds begin to mature. As each bond matures, assets are paid out to investors. Bond UITs come in a wide range of offerings, including those that specialize in domestic corporate bonds, international corporate bonds, domestic government bonds (national and state), foreign government bonds or a combination of issues.
While UITs are designed to be bought and held until they reach termination, investors can sell their holdings back to the issuing investment company at any time. These early redemptions will be paid based on the current underlying value of the holdings.
Investors in bond UITs should make particular note of this because it means that the amount paid to the investor may be less than the amount that would be received if the UIT was held until maturity, as bond prices change with market conditions.
Some UITs permit investors to exchange their holdings for a different UIT at a reduced sales charge. This flexibility can come in handy if your investment objectives change and the UIT in your portfolio no longer meets your needs.
The Bottom Line
UITs are legally required to provide a prospectus to prospective investors. The prospectus highlights fees, investment objectives and other important details. Investors generally pay a load when purchasing UITs, and accounts are subject to annual fees. Be sure to read about these fees and expenses before you make a purchase.
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