A unitary investment trust (UIT) is a US investment company that purchases and holds a portfolio of stocks, bonds, or other securities. ITUs share some similarities with two other types of investment firms: open-end mutual funds and closed-end funds. All three are collective investments in which a large pool of investors pool their assets and entrust them to a professional portfolio manager. Units of the trust are sold to investors or “unitholders”.
Like open-end 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-end funds can be bought and sold directly through fund companies. In some cases, ITUs can also be sold on the secondary market.
Like closed funds, ITUs are issued through an Initial Public Offering (IPO). But if mutual funds are bought during the IPO, there are no built-in gains to be found. Each investor receives a base price which reflects the net asset value (NAV) on the date of purchase, and tax considerations are based on the NAV.
Like open-end mutual funds, ITUs often have low minimum investment requirements.
Open-end funds, on the other hand, pay dividends and capital gains every year to all shareholders, regardless of when the shareholder joined the fund. This could mean, for example, that an investor buys into a fund in November, but owes capital gains tax on gains realized in March. Even if the investor did not own the fund in March, the tax payable is shared among all investors on an annual basis.
Unlike mutual funds or closed-end funds, an ITU has a termination date. This date is often based on the investments held in his portfolio. For example, a portfolio that holds bonds might have a bond ladder made up of five, 10 and 20 year bonds. The portfolio would end at the maturity of the 20-year bonds. Upon termination, investors receive their pro rata share of ITU’s net assets.
Although the portfolio is built by professional investment managers, it is not actively traded. Thus, after its creation, it remains intact until it is dissolved and the assets are returned to investors. Securities are only sold or bought in response to a change in the underlying investments, such as a business merger or bankruptcy.
Key points to remember
- A mutual fund invests for the investor or unitholder in much the same way as traditional funds.
- ITUs have a predetermined expiration date, which makes them function as a bond or similar debt instrument.
- Investors prefer bond UITs over equity UITs, simply because bond UITs are more predictable and less likely to incur losses. The shares are sold in the ITU upon expiration, which does not allow the investor to recoup his losses.
There are two types of ITUs: equity trusts and bond trusts. Equity trusts conduct IPOs by making shares available for a specific length of time known as an offer period. Investor money is collected during this period and then the shares are issued. Equity trusts generally seek to provide capital appreciation, dividend income, or both.
Trusts that seek income can provide monthly, quarterly, or semi-annual payments. Some ITUs invest in national stocks, some invest in international stocks and some invest in both.
Bond UITs have always been more popular than equity UITs. Investors looking for stable and predictable sources of income often buy ITU bonds. Payments continue until the bonds begin to mature. As each bond matures, the assets are paid out to investors. ITU bonds come in a wide range of offerings, including those that specialize in domestic corporate bonds, international corporate bonds, national government bonds (national and state), corporate bonds Foreign states or a combination of issues.
Prepayment / Exchange
While UITs are designed to be bought and held until terminated, investors can sell their holdings back to the issuing investment firm at any time. These prepayments will be paid on the basis of the current underlying value of the holdings.
Investors in bond UITs should take this into account as it means that the amount paid to the investor may be less than the amount that would be received if UIT were held to maturity, as bond prices change with the market conditions.
Some UITs allow investors to exchange their holdings for another UIT at a reduced sale price. This flexibility can come in handy if your investment goals change and the ITU in your portfolio no longer meets your needs.
The bottom line
ITUs are legally required to provide prospectus to potential investors. The prospectus highlights fees, investment objectives and other important details. Investors generally pay a charge when purchasing ITU and accounts are subject to an annual fee. Make sure you read these fees and expenses before making a purchase.