Learn how UITs and mutual funds are alike and how they differ, and find out how you can use them in your portfolio.
What Are UITs?
Simply put, unit investment trusts are a type of legal trust fund. Rather than being set up to save money for a person or a cause, it acts as a tool for investing. It pools the money of many investors together into a single fund, which is then used to purchase shares of stocks, bonds, or other securities. The company or sponsor that manages the fund makes the buying decisions, and these stay intact until the end date. In other words, holdings are not traded for other assets but are bought and held for the trust’s lifetime. A UIT is set up like a classic trust fund, with the portfolio fully formed on the day it is signed. Upon termination, UITs act like closed-end funds in that they issue a set number of shares. These shares are called “units.” The securities within a UIT portfolio can be actively traded, but only between investors who participate in the fund from the start.
Similarities Between UITs and Mutual Funds
UITs are similar to mutual funds in that an investor can redeem shares (vs. trading on a stock exchange) from the UIT sponsor. In fact, UITs and mutual funds are alike in many ways. Here are the main features.
Diversified Portfolios
Both UTIs and mutual funds are designed to hold a diverse array of assets. On a high level, they don’t set limits on types of holdings, and each may consist of stocks, bonds, or other investments, though certain funds may have their own rules. Fund managers can diversify a portfolio to align with its design. If you are looking for a high-risk, high-reward UIT, find a fund that is built on units of only high-risk investments. If you want to keep your risk low, look for a fund whose managers have designed a fund that slowly builds returns over a long period with low risk by forming units made of lower-risk assets.
Capital Gains Distributions
Both UITs and mutual funds are required to distribute capital gains and dividends to their shareholders. Capital gains are the profits you get from the sales of assets. When units are sold or when the UIT ends, the managers must distribute earnings to the shareholders. Periodic payments, called dividends, must be paid to shareholders as well.
Regulations
Both UITs and mutual funds are regulated by the U.S. Securities and Exchange Commission (SEC). The SEC oversees all trade activities on U.S. exchanges. UITs are bought and sold on U.S. exchanges, so they are subject to these regulations.
Differences Between UITs and Mutual Funds
Here are the main ways in which unit investment trusts and mutual funds differ:
Number of Shares
When a UIT is first formed, the design puts a limit on the number of available shares. The shares cannot be split or merged, and the number of shares cannot be increased or decreased. For the most part, mutual funds are more open and can issue as many shares as people are willing to buy.
Active vs. Passive
Mutual funds are managed, which means that the underlying stocks, bonds, or other assets can be changed if they do not perform as well as investors expect them to. UITs are not actively managed this way; assets are bought at the start and then let ride. Though rare, in some cases, trust sponsors are able to replace assets that are not performing well.
Share Exchange
Unit investment trusts generally allow shares to be traded between existing shareholders, with fund sponsors in charge of facilitating these trades. One way to think about this is that when you invest in a UIT, it’s like buying into a bound or island market, along with the other investors in the trust. Shares cannot move in or out of the trust. Still, you can work with the sponsor to trade amongst yourselves. If you invest in a mutual fund, you are one of many investors who are not tied to an end date or a set number of shares. You can rotate finances between mutual funds. This allows you to rebalance your portfolio over time, as market conditions change or as you age. UITs don’t allow for this perk because the assets are set up front.
Should You Invest in a UIT?
Most unit investment trusts have terms of one year, and longer terms are hard to find. Keep this factor in mind if you’re thinking about using one to balance risk in your portfolio, or if you are looking for a long-term rather than a short-term investment. Let’s walk through the thought process for a one-year UIT. The risk of a UIT depends upon the units it is built around. If the shares are from large market capacity companies that have been around for a while and weathered many ups and downs in the market, there might be less risk than from shares of small market capacity companies that haven’t yet worked through a market downturn. You should also think about how you plan to use your gains at the end of the year term. Will you roll them into a new UIT? If so, look for a series. Your goals, interests, and how much risk you can handle will all factor into which type of UIT you can pull into your portfolio.
