Unit Investment Trust (UIT): Definition and How to Invest

What Is a Unit Investment Trust (UIT)?

A unit investment trust (UIT) is an investment company that offers a fixed portfolio, generally of stocks and bonds, as redeemable units to investors for a specific period of time. It is designed to provide capital appreciation and/or dividend income. Unit investment trusts, along with mutual funds and closed-end funds, are defined as investment companies.

Key Takeaways

A unit investment trust (UIT) is a U.S. financial company that buys or holds a group of securities, such as stocks or bonds, and makes them available to investors as redeemable units.
UITS are similar to both open-ended and closed-end mutual funds in that they all consist of collective investments in which many investors combine their funds to be managed by a portfolio manager.
Like open-ended mutual funds, UITs are bought and sold directly from the company that issues them, although sometimes they can be bought on the secondary market; like closed-end funds, UITs are issued via an initial public offering (IPO).
Unlike mutual funds, UITs have a stated expiration date based on what investments are held in its portfolio; when the portfolio terminates, investors get their cut of the UIT's net assets.
Also unlike mutual funds, UITs aren't actively-traded, meaning securities aren't bought or sold unless there's a change in the underlying investment, such as a corporate merger or bankruptcy.

Understanding Unit Investment Trusts (UITs)

Investment companies offer individuals the opportunity to invest in a diversified portfolio of securities with a low initial investment requirement. UITs are sold by investment advisors and an owner can redeem the units to the fund or trust, rather than placing a trade in the secondary market. A UIT is either a regulated investment corporation (RIC) or a grantor trust. A RIC is a corporation in which the investors are joint owners, and a grantor trust grants investors proportional ownership in the UIT's underlying securities.

How Investments Are Sold

Investors can redeem mutual fund shares or UIT units at net asset value (NAV) to the fund or trust either directly or with the help of an investment advisor. NAV is defined as the total value of the portfolio divided by the number of shares or units outstanding and the NAV is calculated each business day. On the other hand, closed-end funds are not redeemable and are sold in the secondary market at the current market price. The market price of a closed-end fund is based on investor demand and not as a calculation of net asset value.

UITs often have a set maturity date between 12 to 24 months; during this time period, securities usually can not be sold.

Types of Unit Investment Trusts

Though the underlying characteristics of a UIT are often the same across different types of trusts, there are different strategies for UITs. These different types will vary in the underlying assets that are purchased and held, as each of the following UITs will have a different investment strategy:

Strategy Portfolio: This type of UIT strives to beat a market benchmark and outperform general investments. This UIT leverages fundamental analysis to determine what investments may beat the market.
Income Portfolio: This type of UIT strives to generate dividend income. It often de-prioritizes capital appreciation in favor of generating income.
Diversification Portfolio: This type of UIT strives to diversification portfolio assets across a broad range of investments. It aims to minimize risks.
Sector-Specific Portfolio: This type of UIT strives to focus on a very specific or niche market. This UIT is often higher risk, though this may result in higher profit.
Tax-Focused Portfolio: This UIT strives to invest in tax-benefit or tax-deferred investments. This includes investing in state-exempt or federal-exempt fixed income securities.

Unit Invest Trusts vs. Mutual Funds

End Dates

Mutual funds are open-ended funds, meaning that the portfolio manager can buy and sell securities in the portfolio. Meanwhile, a UIT pays interest income on the bonds and holds the portfolio until a specific end date when the bonds are sold and the principal amount is returned to the owners. Investors may prefer UITs if they're looking for investments with clearly defined start and stop schedules. a UIT may also be rolled into other another UIT if it is part of a series.

Number of Shares

Many investors prefer to use mutual funds for stock investing so that the portfolio can be traded. If an investor is interested in buying and holding a portfolio of bonds and earning interest, that individual may purchase a UIT or closed-end fund with a fixed portfolio. The UIT will have a specified limit on the number of available shares that cannot be merged or split.

Level of Activity

The investment objective of each mutual fund is to outperform a particular benchmark, and the portfolio manager trades securities to meet that objective. A stock mutual fund, for example, may have an objective to outperform the Standard & Poor’s 500 index of large-cap stocks. Meanwhile, UITs are not actively managed. Assets are purchased upfront, then those assets are held for the duration of the UIT. In rare cases, trust sponsors may be allowed to exchange the trust assets.

There are stock and bond UITs, but bond UITs are typically more popular than their stock counterparts, as they offer predictable income and are less likely to suffer losses.

Advantages and Disadvantages of UITs

Pros of UITs

Unit Investment Trusts (UITs) have several specific investment advantages. UITs provide investors with access to a diversified portfolio of securities; this can help to reduce the risk of losses due to any single security's underperformance. Be mindful that some UITs are industry-specific (i.e. 100% invested in healthcare), and these UITs do hold greater risk.

UITs are required to disclose their portfolios regularly, providing investors with greater transparency into their holdings and investment strategy. In addition, UITs are generally passive investments. This means they do not involve active management or frequent trading. This can result in lower fees and expenses compared to actively managed funds. UITs are also typically structured as pass-through entities, which means they do not pay taxes at the trust level. This can result in greater tax efficiency.

UITs often have low minimum investment requirements, making them accessible to a wider range of investors. In addition, more investors may appreciate the simplicity of a UIT. UITs have a fixed portfolio of securities and a set investment strategy. This means their performance is usually more predictable than actively managed funds that may change their holdings and investment strategy over time.

Con of UITs

UITs unfortunately have a number of downsides as well. Because UITs have a fixed portfolio of securities and a set investment strategy, investors have little control over the investments made by the trust. In some cases, poor performers are also retained and sponsors usually maintain UIT assets without trading away or changing strategy.

As mentioned before, while UITs do provide some diversification, they typically invest in a specific market sector or asset class. This means they may not provide the same level of diversification as more broadly diversified investments.

UITs are designed to be long-term investments, so they may not be appropriate for investors who need access to their funds on short notice. UITs are also not traded on exchanges like mutual funds and may incur fees upfront, so investors may have difficulty buying or selling units or must be prepared to incur higher costs when purchasing the investment.

In some cases, UITs may not provide as much information about their investment strategy or performance as other types of investments. This includes not having as much transparency around fees, expenses, or future plans for changes in assets.

Pros

May promote diversification depending on assets selected
May be transparent as there are specific reporting requirements
May incur less fees due to passive management
May be more predictable as there is often a set investment strategy
May be tax-efficient depending on the UIT strategy

Cons

May be less flexible as the UIT strategy is usually not changed
May be less diversified if invested in a single industry or asset class
May front-loan fees
May be intended for long-term holding periods with limited liquidity
May have limited information about fees, expenses, or future strategy

UITs and Taxation

UITs are generally structured as pass-through entities for tax purposes. This means UITs often don't pay taxes at the trust level. Instead, income, gains, and losses are passed through to the investors in the trust. As a result, investors are responsible for paying taxes on their share of the trust's income, gains, and losses and the trust is tax-exempt.

The tax treatment of a UIT can vary depending on the types of securities held by the trust and the investor's individual tax situation. For example, if the trust holds stocks or other securities that pay dividends, the dividends will be passed through to the investor and taxed as ordinary income. Similarly, if the trust sells securities for a profit, all capital gains are passed through to the investor.

One potential tax advantage of UITs is that they are generally structured as a passive investment. This means that because investments are bought and sold less frequently, they may have lower turnover and generate fewer capital gains than actively managed funds. This can result in greater tax efficiency for investors looking to minimize their capital gains taxes.

UIT Costs

Like other forms of investing, UITs carry with them a variety of costs. Some UITs charge a sales charge called a load. This sales charge is typically a percentage of the investment amount and can range from 1% to 5% or more.

UITs typically charge a management fee which is a percentage of the assets held in the trust. The management fee covers the costs of managing the portfolio and other administrative expenses, though these fees may be less than actively managed investments.

UITs also charge trustee fees. These trustee fees cover the costs of the trustee responsible for overseeing the trust. Trustee fees are typically a fixed amount or a percentage of the assets held in the trust, though there may be other expenses included specific for legal, accounting, custody, or administration fees.

Real-World Example

Guggenheim's Global 100 Dividend Strategy Portfolio Series 14 (CGONNX) was founded on March 15, 2018 with the intent to provide dividend income. It contained 100 diversified positions: 45.16% invested in large-cap stocks, 26.94% in mid-caps, and 27.90% in small caps. Roughly half of the securities are invested in U.S. stocks, with the balance invested in many other countries. Allocation reflects many sectors as well. Each company it holds represents roughly 1% of the portfolio.

This UIT was created with a mandatory maturity date of June 17, 2019. Since the maturity date of this UIT, Guggenheim has continually offered new UIT offerings. For example, the Global 100 Dividend Strategy Portfolio Series 24 was created on Sept. 9, 2020 with a mandatory maturity date of Dec. 17, 2021.

How Does a Unit Investment Trust Work?

A UIT is a type of investment vehicle that pools money from multiple investors to purchase a fixed portfolio of securities, such as stocks or bonds. Once the trust is created, investors purchase units that represent a proportional ownership interest in the underlying assets. The trust is then managed, and income is distributed over the life of the assets. Undistributed long-term capital gains are reported to shareholders on IRS Form 2439.

What Is the Primary Benefit of a Unit Investment Trust?

Many may argue that the main benefit of a UIT is the simplicity. Because it is a passive investment with a defined strategy, the assets of a UIT are usually not sold prior to maturity once they are purchased. Therefore, investors usually like the straight-forward nature of knowing exactly what securities will be held, what timeline is being managed, and what risks are being recognized.

What Is the Main Risk of a Unit Investment Trust?

The benefit above may also translate to one of the greatest downsides of a UIT. Because the assets are not frequently bought or sold, investments often lock into an investment plan that is not changed. The assets may not be re-evaluated as they are being held, and investors may lose money.

The Bottom Line

A UIT is very similar to a mutual fund. However, this investment vehicle often employs a passive investment strategy. Once securities are purchased, a UIT holds the assets for a predetermined amount of time. This gives investors peace of mind knowing the risk and diversification of the portfolio in addition to knowing the tax strategy of the underlying assets.