Pooling Money: Understanding Open-Ended Investment Trusts


“Don’t put all your eggs in one basket.” This timeless adage sums up the concept of diversification well – a way in which investors can manage risk in their portfolios by allocating their investments both among and within different asset classes.

When it comes to financial products that offer diversification, you have no shortage of choices. Mutual funds are just one of those options.

Mutual funds, or UITs, fall into the same category as mutual funds and closed-end funds. All three are investment companies, which means that they pool the money of many investors and invest it according to specific investment objectives.

The main difference from UITs, however, is that once an UIT has defined its portfolio, it remains the same throughout the life of the fund (barring a major corporate event, such as a merger or bankruptcy proceedings) and the duration is fixed.

How do they work?

ITUs raise funds by selling shares called “units” to investors, usually as part of a single public offering. Each unit represents a portion of the trust’s ownership and gives the investor a right commensurate with the income and capital gains generated by the fund’s investments, usually stocks or bonds.

The performance of an ITU’s underlying investments, less the fund’s expenses, determines the return on the trust’s investment. These investments are generally fixed, with an ITU generally holding the securities in which it invests during the life of the fund, which is determined at the time of the fund’s initial offer.

ITUs are designed to be held for the life of the fund, but investors can usually redeem their shares early if their investment objectives change.

What do I need to know?

ITUs may vary in their investment strategy, risk profile, performance history, management and fees.

Before investing in an ITU, it is important to fully understand the specific investment strategy or objective of a trust. ITUs can invest in a wide variety of securities, but most focus on stocks and bonds. And ITU will inherit all the risks associated with the securities in which it invests, such as credit and market risk.

You’ll also want to know the ITU termination date, which is the date the trust will be dissolved. While this date would typically be 15 months to two years, it could be over 50 years away. If the date is far enough in the future, you’ll want to get a good idea of ​​how easy or difficult it is to sell your units to other investors or to redeem your units from ITU if you need to.

How much will it cost me?

All ITUs charge a fee, but a small percentage difference in fees can make a big difference in the return on your investment. It is therefore important to know all the fees associated with any trust in which you invest.

Some fees, such as an initial sales charge, creation or redemption fee, are billed at specific times, depending on the actions you take, and some, such as annual operating fees, are billed on a continuous basis.

The charges for an ITU are described in the trust prospectus, which you can obtain from the ITU sponsor or by researching the United States Securities and Exchange Commission. EDGAR database. But you may also have to pay processing or administration fees charged by your brokerage. Be sure to ask your investment professional about any fees before you make an investment.

Often, ITU sponsors offer sales charge discounts to investors on certain purchases, for example when an investor renews money from a previous ITU series. It is important to check the prospectus and speak to your financial professional to determine if you may be eligible for such discounts.

What happens at maturity?

If you hold an ITU until its termination date, you will have several options. You can generally:

  • Do not do anything. When an ITU matures, it will liquidate its portfolio and share the proceeds, if any, among investors.

  • Renew the investment. Alternatively, investors may be able to transfer the value of this cash payment to a new series from the same or another ITU by the same sponsor. Note: Although the sponsor will often reduce the cost of selling to investors, you will still have to pay taxes on capital gains from a rollover, just as you would if you received a cash distribution.

  • Distribution in kind. If you really want to continue with the same investment even after a trust ends, you may, in certain circumstances, be able to ask the ITU sponsor to pay your share of the trust in the form of shares in the funds. underlying investments.

Nothing else?

Although ITUs aim to achieve a specific goal, such as capital appreciation or income generation, there is no guarantee that any given trust will achieve that goal.

Plus, you can get less than expected if market conditions change, especially if you are invested in an ITU bond. While bond investors receive the face value of the issue at maturity, the value of that bond in the market may fluctuate over its lifetime and may trade below its face value depending on the market. changes in market interest rates, or if the company that issued the bond is having difficulty paying its debts. For the same reasons, an ITU bond can lose value if its investments trade below face value.

Investors in fixed income ITUs should also be aware of the tax status of the fund, as it may be taxable or tax-advantaged. Additionally, while some fixed income ITUs purchase insurance to secure scheduled principal and interest payments, this insurance will not protect you in the event that the ITU issuer experiences credit issues.

Beyond that, be aware that some UITs may terminate early under certain conditions. If you plan to hold an ITU until termination, be sure to note the specific early termination conditions in the trust prospectus.

And finally, if your registered financial professional recommends that you transfer an ITU position to a new ITU before the due date, be sure to ask if this will incur any increased selling costs, either immediately or over time.

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