Types of Unit Trusts
In many countries, the term unit trust describes a mutual fund. Australia, Ireland, New Zealand and the United Kingdom have mutual fund style unit trusts. In the U.S., the term unit trust applies to Unit Investment Trusts, or UITs. These have a unique structure that may fit well in certain investment portfolios.
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Background
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A UIT is formed when a trust sponsor issues a fixed number of shares that are ownership units or units of a fixed pool of assets. Units are issued just one time and are not actively traded. Most UITs have a fixed termination date, ranging from one to 30 years. Unit trusts are not actively managed, do not have a board of directors or an investment adviser.
The securities in an UIT are set when the trust is formed. At the termination date, all securities are sold and the proceeds distributed to the unit holders. Trust sponsors will redeem units early at net asset value (NAV), if an investor wants out of the trust before the termination date.
Types
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Unit investment trusts can be broadly divided into two types. Income trusts hold debt instruments such as government, corporate or municipal bonds. Equity trusts will hold stocks to match an index or other criteria. Unit trusts are regulated by the Securities and Exchange Commission. Sponsors are required to provide a prospectus listing the trust's objectives, holdings and sales charges.
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Income Trusts
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Unit investment trusts are a convenient way to add bonds to an investment portfolio. The trust will hold a pool of bonds with the same maturity date as the termination date of the trust. Income UITs provide monthly interest checks, diversification across numerous bonds and the ability to invest as little as $1,000. Trusts that provide tax-free income by holding municipal bonds are very popular. To buy individual muni bonds, an investor usually needs a minimum of $25,000 and at least $100,000 to get some diversification in their municipal bond holdings. A unit trust provides more diversification and liquidity compared to individual bonds. Income UITs are also available for government bonds, mortgage backed securities, corporate bonds and international bonds.
Equity Trusts
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Equity unit investment trusts follow a buy-and-hold strategy of stock investing. The trust will hold specific stocks until the termination date of the trust. Many equity trusts are formed to follow a specific stock-selection strategy for a set time period. The "Dogs of the Dow" investment strategy, which involves buying the 10 highest yielding Dow Jones Industrial Average stocks and holding them for a year is a popular UIT strategy.
Potential
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Income unit investment trusts can provide a steady income and return of principal at termination. They are popular with retired investors. Tax-free municipal bond UITs make up the largest proportion of UIT assets.
Equity unit trusts appeal to stock investors who want a diversified buy-and-hold portfolio following a particular strategy. The trust portfolios are often selected by the top analysts at major investment firms or follow a stock-selection strategy that has proven successful.
Considerations
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Unit investment trusts are purchased through investment advisers or stock brokers. The fees to purchase units are set in the prospectus and there is no advantage to buying them online. Talk to a financial representative to get the details of portfolio holdings, termination dates and fees.
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