Unit Investment Trusts (UITs)
Unit investment trusts (UITs) are fixed portfolios of a particular asset class that were created to effect some particular investment strategy. The trust indenture is the legal agreement specifying the terms of the trust and the obligations of the trust sponsor, who creates the trust, and the investors of the trust, who are the trust beneficiaries. Like closed-end mutual funds, UITs are registered under the Investment Company Act of 1940, but their holdings are fixed and cannot be changed. Shares of UITs are often called units and the shareholders are unitholders. Units are issued as redeemable shares, meaning that the trust redeems the shares from investors and then sells them to other investors through a secondary market. A UIT may be structured at either as a regulated investment company (RIC) or as a grantor trust. Investors in RIC's have voting rights but not a direct interest in the trust investments, whereas a grantor trust gives the unitholders a proportional interest in the underlying securities.
A unique feature of a UIT is that it is self-liquidating: the trust terminates at a predetermined date based on the trust assets, usually 15 or 24 months. So UITs have a maturity date. In a bond fund, the maturity date is the date the bonds mature. Equity UITs have a specified maturity date that is determined by the strategy being pursued. For instance, there are UITs that use the Dogs of the Dow strategy, which is to buy the highest yielding stocks of the Dow Jones Industrial Average, hold them for 1 year, then sell them to buy the stocks with the current highest yield, which involves rolling 1 UIT into another.
When UIT is liquidated, the investor has 3 choices:
- reinvest the proceeds into another trust at a reduced sales charge from the same sponsor
- receive a cash distribution
- receive an income distribution of the securities in the trust, but only investors with at least 2500 units can do this.
There are several main types of UITs: equity trusts and bond trusts, which can be further subdivided into taxable trusts, consisting of corporate bonds and tax-exempt trusts consisting of municipal bonds. Equity trusts can also be further subdivided into domestic and international or global trusts, holding such high-yielding assets as dividend-paying common stocks, preferred stocks, real estate investment trusts, or master limited partnerships. UITs can also be segmented into categories: asset allocation, sector, target strategies, and "theme" portfolios. Equity trust assets far exceed those of bond trusts.
Defined Asset Funds (also, Equity Investor Funds) are another example of UITs — offered by Merrill Lynch, Salomon Smith Barney, Prudential Securities, Morgan Stanley, and UBS/Paine Webber Defined Asset — that invest in a particular class of securities, such as blue chips, REITs, or utilities. Sometimes the securities are screened from a particular index in the hopes of outperforming the index. Some UITs have specialized holdings, such as companies that are likely to be acquired, or that focus on renewable energy, or they might hold a particular type of security, such as preferred stock.
UIT price quotes can only be obtained from the broker, or for listed UITs, an investor can use NASDAQ's Mutual Fund Quotation Service. UIT units can be redeemed by the trust sponsor at the current net asset value (NAV) without any additional fees or commissions. Like CEFs, UITs do not need to maintain liquidity to redeem shares.
The disadvantages of unit investment trusts are the high fees. UITs are usually sold by brokerages, which charge a commission. There is often a front load and a back load, as well as ongoing management fees. Some UITs also charge 12b-1 fees to market their shares.
A typical UIT charges 3 fees:
- repurchase fee, which is a deferred sales charge, collected when the units are redeemed
- creation and development fee, which is the dollar charge per unit, collected at the end of the initial public offering and can be as much as 1% of the IPO
- redemption charge, which is a percentage of the public offering price, which is higher than the NAV of the fund. Because UITs have to be purchased from the broker, the broker charges a commission that can be almost 4% of the NAV.
However, annual UIT expenses are low, often 0.25% to 0.3% of assets, since a UIT does not trade securities after it is formed, so there are few, if any, transaction costs. As with mutual funds, sales charges can be less if the investor buys at least $50,000 of units.
Another disadvantage results from the fact that a UIT is a passively managed fund. Because the UIT portfolio is fixed, changes in the market may cause UIT income to decline, since the fund manager cannot easily remove declining assets, which is a primary reason why the terms of most UITs does not exceed 2 years. Many UITs also try to minimize the disadvantage of a fixed portfolio by fully replicating an index. Moreover, because the number of units are fixed, it may not be possible to buy the number of desired units. Other disadvantages may be specific to the type of securities held by the trust. For example, most corporate bonds have call provisions, so income from a UIT that holds corporate bonds may decline over its term as some of its bonds are called by the issuer.
UITs also have no performance history, since their average term is 15 months to 2 years. Because of the funds' short lifespans, the funds' issuers frequently use back tests to substitute for actual performance history, which uses historical data to arrive at a performance value. Thus, the issuers argue that if the UIT had existed in the past, this is how it would have performed. The problem with this misleading yardstick is that, as oft been said with investment strategies, the past is no indicator of future performance, and, often, the composition of the UIT is selected so that a high performance record can be constructed. Even the beginning and end dates for the historical record are selected to maximize the historical gains.
Because of these disadvantages, UITs have declined, especially since index funds and exchange-traded funds can accomplish the same investment objectives, but with lower expenses.