What is a closed-end investment trust (WHFIT)?
An open-ended investment trust (WHFIT) is a type of open-ended investment trust (UIT) with at least one stake held by a third party. Investors who buy shares of the trust receive any regular payments of interest or dividends earned on the shares or bonds held in the trust.
Key points to remember
- An open-ended investment trust (WHFIT) is an investment vehicle in which at least one interested third party is involved.
- The third party, or intermediary, is responsible for holding the shares as depositary.
- Without this intermediary role, the WHFIT would simply be a Unit Investment Trust (UIT), and in many ways they operate identically from an investor’s perspective.
- WHFITS may invest in a fixed portfolio of stocks and bonds, or in real estate mortgage investments.
Understanding Widely Owned Closed-Ended Investment Trusts
Widely owned closed-end investment trusts must have at least one third party interest holder or an intermediary. Otherwise, they work the same as any other mutual fund offering stocks in a fixed portfolio of assets to potential investors. Since the investors who fund the initial purchase of portfolio assets generally participate as trust interest holders, large-stake closed-end investment trusts fall into the category of settlor trusts.
Trust interest holders receive dividends or interest payments derived from the underlying assets of the portfolio based on the proportion of shares they hold. The presence of intermediaries in the trust means that investors can have a direct interest in the trust or an indirect interest if an intermediary such as a broker holds the shares on behalf of another investor.
WHFITs are classified as pass-through investments for income tax purposes. The parties involved in creating and maintaining a WHFIT include:
- Licensors: Investors who pool their money to buy the assets placed in the trust.
- Curator: Usually a broker or financial institution that manages the assets of the trust.
- Intermediate: Usually a broker who holds the unit shares of the trust on behalf of his client / beneficiary.
- Trust interest holder: This is the investor who owns unit shares in WHFIT and is entitled to the income generated by the trust.
Other types of investment companies
The United States Securities and Exchange Commission (SEC) considers mutual funds to be one of three types of investment companies, along with mutual funds and closed-end funds. Like mutual funds, open-ended investment trusts offer investors the ability to buy stocks in a diversified portfolio of underlying assets at a lower cost and with less hassle than it would take. to constitute the portfolio independently. Unlike mutual funds, open-ended investment trusts offer a static portfolio of assets. They also specify a termination date on which the trust will sell the underlying assets and distribute the proceeds to investors.
The US Internal Revenue Service generally treats broad-based investment trusts as flow-through entities for tax purposes. For this reason, the trust itself does not pay tax on its income. Instead, people who invest in the trust are given a Form 1099 detailing their annual income and must pay taxes on those amounts as they would any other income earned.
Widely held mortgage trusts
A common variety of open-ended investment trusts, the widely held mortgage trust, offers portfolios comprised of mortgage assets. In these cases, the trust typically purchases a set of mortgages or other similar debt obligations related to real estate. Investors earn returns based on the interest earned on the underlying mortgages. The three major federal mortgage lenders, Freddie Mac, Fannie Mae, and Ginnie Mae, all periodically issue widely held mortgage trusts.
Related to this is a Real Estate Mortgage Investment Conduit (REMIC), which is a special purpose vehicle used to consolidate mortgages and issue Mortgage Backed Securities (MBS). The conduits of real estate mortgage investment hold commercial and residential mortgages in trust and issue interest in those mortgages to investors.
The differences between ITUs and mutual funds
Mutual funds are open-ended funds, which means that the portfolio manager can buy and sell securities in the portfolio. The investment objective of each mutual fund is to outperform a particular benchmark, and the portfolio manager trades securities to achieve this objective. An equity mutual fund, for example, may aim to outperform the Standard & Poor’s 500 index of large-cap stocks.
Many investors prefer to use mutual funds to invest in stocks so that the portfolio can be traded. If an investor wants to buy and hold a bond portfolio and earn interest, they can buy an ITU or a closed-end fund with a fixed portfolio. An ITU, for example, pays interest income on the bonds and holds the portfolio until a specific end date when the bonds are sold and the principal amount is returned to the owners. A bond investor can own a diversified bond portfolio in an ITU, rather than managing interest payments and bond buybacks in a personal brokerage account.