Unit investment trusts
Unit investment trusts (UITs) are comparable to mutual funds but offer some unique investment advantages.
What is a Unit Investment Trust?
A unit investment trust (UIT) offers a fixed portfolio of professionally selected stocks or bonds to investors, and generally have a low initial investment requirement. Since unit investment trusts are fixed, once the portfolio of stocks or bonds are chosen, they typically don’t change. These portfolios are not actively traded, so you can have a better understanding and visibility into what you own.
Investment companies issue and invest in securities, which appeals to investors who want to buy into a diversified portfolio of securities rather than individual ones.
There are three basic types of investment companies:
- Open-end funds
- Closed-end funds
- Unit investment trusts
What are the different types of UITs?
Although UITs can invest in a variety of securities, most are typically either stock or bond trusts.
Stock unit investment trusts can focus on capital appreciation, dividend income, or both. Stock trusts are more vulnerable to market risks, making them less steady and less predictable than bond trusts.
Bond trusts typically experience less fluctuation in value, which tends to lower risk and helps provide stability in the value of your portfolio. Bond trusts are selected based on a stated investment strategy. These strategies usually focus on providing predictable monthly income and are typically categorized as either “taxable” or “tax-exempt.”1 Fixed-income UITs are portfolios of bonds.
Taxable trusts own bonds such as corporate, U.S. government or taxable municipal bonds. Tax-exempt trusts own tax-exempt municipal bonds. The maturities of the bonds held within the portfolio determine the expected life of the trust, with principal returned as the individual bonds mature or are called. Fixed-income UITs with different maturities may help improve the diversification and laddering of your fixed-income portfolio.
How do bond UITs work?
There are three main features of bond UITs that can provide you with a better understanding of how these fixed-income investments work.
Fixed-income UITs typically pay you a monthly income, which can be fairly predictable, because the bonds in the trust do not frequently change. When bonds mature or are called, this will result in a return of principal and a decrease in income. The remaining bonds in the trust will continue to generate income over time.
A fixed-income UIT has a finite life and will return a portion of its principal as the bonds in the trust are called or mature. This is different from bond mutual funds and ETFs, which generally reinvest principal into the fund.
Defined par value
The par value is the amount of principal that investors can likely expect to be returned over the remaining life of the trust. Fixed-income UITs have a defined par value based on the bond holdings in the trust.
How do UITs compare to mutual funds?
UITs and mutual funds have many similarities and some key differences.
Both UITs and mutual funds offer diversified portfolios that have been professionally selected for investors. They both provide investors with the opportunity to group or pool their money together to buy securities. Low minimum investment requirements are also generally true for both types of investments. Both are subject to industry regulation to ensure accountability and fairness by the U.S. Securities and Exchange Commission (SEC).
Unlike UITs, bond mutual funds and exchange-traded funds (ETFs) don’t necessarily have a set termination and generally reinvest principal back into the fund as the bonds reach maturity. Mutual funds can also be either actively or passively traded, which can impact fee amounts. UITs are overseen by an investment manager, but their portfolio is fixed and not traded
One of the main characteristics of a UIT is a fixed portfolio that remains unchanged until the predetermined termination date. Since mutual funds are open ended, they are frequently traded and have no set expiration date. UITs are designed to be a longer-term, hands-off type of investment.
What is UIT maturity?
Most UITs have an end date or maturity date. This maturity date marks the end of the UIT, which is then terminated.
If you hold your UIT until this date, you have the option to:
- Sit and wait. Once the UIT matures, it will dissolve the portfolio and return any remaining principal to the investors.
- Roll over your investment. You may roll the value of the cash payout into a new series of the same UIT or another UIT. You will still be responsible for paying taxes on any capital gains.
- Do an in-kind distribution. If you want to continue with the same investment even after a trust terminates, you may, under certain circumstances, be able to request that the UIT sponsor pay out your portion of the trust in the form of stock in the underlying investments.
Can I redeem a UIT early before termination?
You can sell your redeemable units back to the investment company that issued the UIT prior to its maturity date. Keep in mind, early redemptions are paid based on the UIT’s current underlying value. For bond UITs, this amount could be lower or higher in value depending on interest rate markets.
How are UITs taxed?
It’s important to understand the tax considerations of UITs. The termination of a trust is a taxable event, regardless of whether the proceeds are rolled over into a new trust. Interest and dividend payments, returns of principal and termination of UITs are the most common taxable events to consider. Review the prospectus and consult with a tax professional to understand your personal situation.
Your UIT fees and expenses may include:
- Sales charges
- Organizational costs
- Annual administrative expenses
What are the UIT risks?
Fixed-income UITs contain bond investments that are subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease. If a bond within a UIT is called, the principal will be returned, subjecting the investor to reinvestment risk.
Also, bonds in UITs are subject to credit risk. As prices can fluctuate based on market concerns about financial condition, the UIT issuer may not be able to pay interest or repay principal. UITs holding fewer securities can have more price volatility than more diversified trusts with a greater number of holdings.
It's important to carefully review the prospectus with your financial advisor and discuss the risks associated with the specific UIT strategy you are considering.
How can I review and compare UITs?
If you’re considering a UIT as an investment, we encourage you to contact a financial advisor to help you get started. Our financial advisors will work with you to determine what’s important to you now and for the future. UITs offer different investment objectives and portfolios. Together we will review your options and design a personalized investment strategy based on your investment goals.
1 The income from bonds within a nontaxable bond UIT is generally federal tax-free. However, activity inside the trust portfolio, including liquidations from other unitholders, may cause early returns of principal distributed to the client. Some or all of the trust’s income and any principal distributions may be reclassified as taxable income or taxable capital gain distributions. This reclassification will be disclosed on the client’s year-end tax documents. Edward Jones, its employees and financial advisors are not estate planners and cannot provide tax or legal advice. You should consult your estate-planning attorney or qualified tax advisor regarding your situation.