Investment unit investment trust

A unit investment trust (UIT) is an American investment company that buys and holds a portfolio of stocks, bonds, or other securities. UIT has some similarities with the other two types of investment companies: open-end mutual funds and closed-end funds. These three are collective investments. A large number of investors combine their assets and entrust them to professional portfolio managers. Units in the trust are sold to investors or “unit holders.”

Basic characteristics

Like open-end mutual funds, UIT provides professional portfolio selection and clear investment goals. They are bought and sold directly from the issuing investment company, just as open-end funds can be bought and sold directly through the fund company. In some cases, UIT can also be sold on the secondary market.

Like closed-end funds, UIT is issued through an initial public offering (IPO). But if you buy a mutual fund during an IPO, you won’t find the embedded income. Each investor receives a cost basis that reflects the net asset value (NAV) on the purchase date, and tax considerations are based on NAV.

Like open-end mutual funds, UIT’s minimum investment requirements are generally lower.

On the other hand, open-end funds distribute dividends and capital gains to all shareholders every year, regardless of the date when shareholders purchase the fund. For example, this may result in investors buying funds in November but paying capital gains taxes on the gains realized in March. Although investors did not own the fund in March, the tax liability is shared annually by all investors.

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Expiration date

Unlike mutual funds or closed-end funds, UIT has a prescribed termination date. This date is usually based on the investments in their portfolio. For example, a portfolio holding bonds may have a bond ladder consisting of 5-year, 10-year, and 20-year bonds. The investment portfolio will terminate at the maturity of the 20-year bond. Upon termination, investors will receive their pro rata distribution of UIT net assets.

Although the investment portfolio is constructed by professional investment managers, trading is not active. Therefore, after creation, it will remain intact until it is disbanded and the assets are returned to investors. Only when the underlying investment changes (such as a company merger or bankruptcy) will the securities be sold or purchased.

Key points

  • Unit investment trusts invest in investors or unit holders, and the investment method is roughly the same as that of traditional funds.
  • UITs have a predetermined maturity date, making them function like bonds or similar debt securities.
  • Compared with stock UIT, investors prefer bond UIT for a simple reason, because bond UIT is more predictable and less likely to suffer losses. The shares are sold in UIT at maturity, which does not allow investors to make up for any losses.

type

There are two types of UIT: stock trusts and bond trusts. Stock trusts conduct initial public offerings by offering shares during a specific time period called the offering period. Collect investors’ funds during this period and then issue shares. Stock trusts usually seek to provide capital appreciation, dividend income, or both.

A trust seeking income may provide monthly, quarterly or semi-annual payments. Some UIT invests in domestic stocks, some invests in international stocks, and some invests in both.

Bond UIT has historically been more popular than stock UIT. Investors looking for a stable and predictable source of income usually buy bond UIT. Payment will continue until the bond begins to mature. As each bond matures, the assets will be paid to investors. Bond UIT offers a wide range of products, including specializing in domestic corporate bonds, international corporate bonds, domestic government bonds (national and state), foreign government bonds, or bonds issued in combination.

Early redemption/exchange

Although UIT aims to buy and hold until termination, investors can sell their shares back to the issuing investment company at any time. These early redemptions will be paid based on the current basic value of the holdings.

Investors of bond UIT should pay special attention to this, because it means that the amount paid to investors may be less than the amount that would be received if UIT is held to maturity, because bond prices will change with market conditions.

Some UITs allow investors to exchange their holdings for different UITs at a lower selling cost. This flexibility will come in handy if your investment goals change and the UIT in your portfolio no longer meets your needs.

Bottom line

UIT is required by law to provide prospectus to potential investors. The prospectus emphasizes fees, investment objectives and other important details. Investors usually pay a certain price when buying UIT, and the account needs to pay an annual fee. Please be sure to read these fees and expenses before purchasing.

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