UNIT INVESTMENT TRUST

A unit investment trust (UIT) is a type of investment fund. A UIT consists of a fixed portfolio of securities—usually bonds —in which the selection of stocks or bonds remains constant during the life of the trust and new securities are not added to the portfolio. UITs may sell nonperforming investments, but the money from the sale is distributed to unit holders rather than being reinvested. Unlike other types of investment funds, such as open-end and closed-end mutual funds, the portfolio is not managed. Instead, it is established for a specified period—typically 20 to 30 years—and is placed under the management of a trustee. After the trust is created, ownership shares, or units, that reflect the value of the underlying assets are sold to investors. The assets cannot be redeemed until maturity. Throughout the holding period, however, unit owners can sell their shares for whatever the market will bear.

As with other investment funds, UITs come with a variety of investment objectives and portfolio options. Some of the major categories include:

• tax-exempt municipal bonds
• corporate bonds
• stocks
• mortgage-backed securities
• U.S. Treasury securities

Although the vast majority of domestic UITs—over 90 percent—concentrate on tax-exempt bonds, that category only represents around 43 percent of total UIT market value. The bull market of the 1990s created strong interest in stock UITs, which has been the fastest-growing category, increasing tenfold for the period 1990-97. In fact, by 1997 stock UITs overtook tax-free bonds in terms of invested market value, amassing close to 49 percent of all UIT dollars. Based on figures from the Investment Company Institute, a trade association for investment firms, as of 1997 there were 11,595 UITs in the United States representing $86 billion in market value.

While equity UITs have flourished, investment in UITs in general has been soft compared to their heyday in the 1980s. The market value of UITs peaked in 1989 at $131 billion, but fell into a protracted decline through the mid-1990s, bottoming out at $73 billion in 1995. At their peak, the value of bond ULTs alone topped $100 billion. Since 1995, they have begun to grow once again, and all of that growth can be attributed to stocks. Investment rates in UITs continue to be dwarfed by interest in mutual funds, which boast a collective market value in excess of $3 trillion.

Unlike managed funds, UITs do not have a board of directors or investment managers. The trustee simply collects the interest income and cash flow from the repayment of the bonds, and distributes the funds to the unit holders until all bonds mature or are called. Because the investments are not directed, annual fees charged to maintain the trust are sometimes lower than fees charged for managed funds. In addition to lower management fees, UITs may provide investors with a diversified portfolio of bonds that offer different maturity dates and an average holding period that complements their financial needs. Indeed, because most UIT assets are invested in bonds, UIT participants purchase shares with the expectation of earning a steady, monthly income and then receiving most of their principal back at expiration. Investors theoretically get the benefit of holding bonds until maturation without the volatility and risks inherent in short-term trading. Thus, unlike in managed funds, UIT shareholders know exactly what they are buying.

Among the drawbacks of UITs are that their investment portfolios are unresponsive to changing market conditions. An individual investment that looks good when the trust is formed, for example, may sour soon afterward. Nevertheless, it cannot be removed from the trust. In addition to that handicap, many UIT holders find that their shares are difficult to liquidate in the open market. Because no one tracks and compares the performance of all UITs on the market, moreover, investors may also have a difficult time comparing UIT alternatives. Finally, the UIT industry is characterized by a lack of standards for advertising and marketing, which dilutes the efficiency of UIT investing for many fund investors.

UITs usually charge a sales fee of 3 percent to 4 percent, although it can range from I percent to 5 percent. Shareholders may also pay a supervisory fee of $1.50 to $1.75 per $1,000 per month. These fees, which are high in comparison to competing no-load funds, have caused some analysts to consider UITs an unwise investment. UIT fees are low to moderate compared to mutual funds with front or back loads. Despite those detractions, UITs, as rejuvenated by stocks, continue to be popular investment vehicles in the United States.