Understanding Unit Investment Trusts (UITs)
A Unit Investment Trust (UIT) is an investment company offering a fixed portfolio of stocks or bonds as redeemable units for a specified period. The primary goals are capital appreciation and/or dividend income. UITs are part of a broader category of investment companies, which also includes mutual funds and closed-end funds.
Key Takeaways
- A UIT holds a portfolio of securities that investors can buy as redeemable units.
- UITs are similarly structured to both open-end and closed-end mutual funds but have unique characteristics in terms of purchase, management, and expiration.
- Unlike mutual funds, UITs have a fixed termination date and do not actively trade their assets.
- Investors get a portion of the UIT’s net assets upon maturity.
- UITs are mostly passive investments and involve less frequent trading.
The Mechanics of Unit Investment Trusts
Investment companies provide opportunities for individuals to invest in diversified securities with a minimal initial investment. Investors can redeem UIT units directly through the issuing company or advisors, rather than through secondary markets. UITs can be classified as either Regulated Investment Corporations (RICs) or grantor trusts. RICs mean that investors are joint owners while grantor trusts grant proportional ownership in the underlying securities.
How Investments Are Sold
VU-MTTs allow investors to redeem units at Net Asset Value (NAV), calculated daily as the total portfolio value divided by outstanding units. Conversely, closed-end funds aren’t redeemable but traded in secondary markets, with their prices determined by investor demand. Most UITs feature a maturity date ranging from 12 to 24 months, during which selling securities is usually restricted.
Types of Unit Investment Trusts
Strategy Portfolio
Seeks to outperform market benchmarks using fundamental analysis.
Income Portfolio
Focuses on generating dividend income, favoring it over capital appreciation.
Diversification Portfolio
Spans investments across multiple asset types to minimize risk.
Sector-Specific Portfolio
Invests in a specific niche market, presenting higher risks but potential higher returns.
Tax-Focused Portfolio
Invests in tax-advantaged or tax-deferred securities.
Comparing Unit Investment Trusts and Mutual Funds
End Dates
Unlike mutual funds, which are open-ended, UITs have fixed end dates, and the assets are held until maturity.
Number of Shares
Without the merging or splitting of shares, UITs have set limits on available units and are suitable for investors interested in fixed portfolios.
Level of Activity
UITs maintain a passive investment strategy where securities are held throughout the UIT’s term, unlike mutual funds that regularly trade assets to meet portfolio goals.
Pros and Cons of UITs
Pros
- Diversification: Offers a broad range of securities.
- Transparency: Regular and detailed disclosure of portfolio contents.
- Lower Fees: Reduced management costs due to passive management.
- Predictability: Consistent strategy and performance.
- Tax Efficiency: Pass-through income resulting in tax advantages.
Cons
- Rigidity: Limited flexibility with a fixed investment strategy.
- Sector-Specific Risk: Higher risk in market-specific investments.
- Front-End Fees: Potential immediate costs upon investment.
- Limited Liquidity: Designed for long-term holding periods.
- Information: Less frequent providing of strategy changes or fee structures.
Understanding UITs and Taxes
UITs benefit from pass-through taxation, eliminating tax at the trust level. Gains, losses, and income are directly passed to investors, who then have tax liabilities based on their portfolios. Fewer trades within Uit portfolios increase tax efficiency by reducing capital gains.
Costs Involved in UITs
Sales Charge
A front-end fee, ranging from 1% to 5% of the investment amount.
Management Fee
A percentage fee of the portfolio’s assets covering administrative expenses.
Trustee Fees
Covers the management and administrative costs of the trustee, including legal and accounting services.
Real-World Example
The Guggenheim Global 100 Dividend Strategy Portfolio Series 14 was launched on March 15, 2018, containing 100 diversified positions across large-cap, mid-cap, and small-cap stocks. It had a set maturity date of June 17, 2019, distributing dividends for its remaining duration.
How Does a Unit Investment Trust Work?
A UIT pulls together investments from various individuals into a fixed portfolio of securities. Once units are bought, investors are entitled to a portion of the trust’s income. The passive nature lets investors rely on unchanged investment strategies over the predetermined time frame.
Main Benefits of Unit Investment Trusts
The principal appeal lies in the UIT’s straightforward approach: a fixed investment strategy offering predictability and transparency, reducing the complexities and frequent trades associated with other investment vehicles.
Main Risks of Unit Investment Trusts
As portfolio strategies are fixed, the lack of flexibility can be a disadvantage. Since assets are typically not revisited or re-evaluated, changing market conditions may negatively affect returns.
The Bottom Line
A UIT is like a mutual fund but is managed passively with a set timeline for its holdings. This passive structure appeals to investors who favor stability and can predict both risk and returns over the investment’s duration.
Related Terms: Mutual Funds, Closed-End Funds, Net Asset Value, Secondary Market.
References
- Guggenheim. “Global 100 Dividend Strategy Portfolio Series 100”.
- Guggenheim. “Global 100 Dividend Strategy Portfolio Series 24”.
