Unit Investment Trusts

Unit investment trusts are pools of money invested in a portfolio that is fixed for the life of the fund. To form a unit investment trust, a sponsor, typically a brokerage firm, buys a portfolio of securities which are deposited into a trust. It then sells to the public shares, or "units," in the trust, called redeemable trust certificates. All income and payments of principal from the portfolio are paid out by the fund's trustees (a bank or trust company) to the shareholders. Most unit trusts hold fixed-income securities and expire at their maturity, which may be as short as a few months if the trust invests in short-term securities like money market instruments, or as long as many years if the trust holds long-term assets like fixed-income securities. The fixed life of fixed-income securities makes them a good fit for fixed-life unit investment trusts. In fact, about 90% of all unit investment trusts are invested in fixed-income portfolios, and about 90% of fixed-income unit investment trusts are invested in tax-exempt debt.

There is little active management of a unit investment trust because once established, the portfolio composition is fixed; hence these trusts are referred to as unmanaged. Trusts tend to invest in relatively uniform types of assets; for example, one trust may invest in municipal bonds, another in corporate bonds. The uniformity of the portfolio is consistent with the lack of active management. The trusts provide investors a vehicle to purchase a pool of one particular type of asset, which can be included in an overall portfolio as desired. The lack of active management of the portfolio implies that management fees can be lower than those of managed funds.

Sponsors of unit investment trusts earn their profit by selling shares in the trust at a premium to the cost of acquiring the underlying assets. For example, a trust that has purchased $5 million of assets may sell 5,000 shares to the public at a price of $1,030 per share, which (assuming the trust has no liabilities) represents a 3% premium over the net asset value of the securities held by the trust. The 3% premium is the trustee's fee for establishing the trust.

Investors who wish to liquidate their holdings of a unit investment trust may sell the shares back to the trustee for net asset value. The trustees can either sell enough securities from the asset portfolio to obtain the cash necessary to pay the investor, or they may instead sell the shares to a new investor (again at a slight premium to net asset value).

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  • nick
    How do Sponsors of unit investment trusts earn a profit?
    3 years ago

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