What Is a Unit Investment Trust (UIT)?

Unit Investment Trusts (UITs) are financial products that offer a structured approach to investing. They represent a type of investment company established to hold a fixed portfolio of securities, which typically remains unchanged for a predetermined period. At the end of this specified duration, the trust is designed to terminate, distributing its assets to investors. UITs function as pass-through entities, meaning that the income and capital gains generated by the underlying securities are passed directly to the unit holders, without being taxed at the trust level.

Defining Characteristics of a UIT

A primary characteristic of a UIT is its fixed portfolio, which means the securities within the trust are generally not actively bought or sold by a manager once the trust is established. Exceptions to this rule are limited, such as in cases of an issuer’s bankruptcy or a corporate merger affecting a security. This fixed nature means UITs are unmanaged.

Another defining feature is their limited life, as UITs are created for a specific duration, which can range from 13 months to as long as 30 years, depending on the underlying investments. Upon reaching this predetermined termination date, the trust liquidates its assets and distributes proceeds to unit holders. UITs are also structured as pass-through entities for tax purposes, allowing income and capital gains to flow directly to investors, who then report these on their personal tax returns, avoiding taxation at the trust level.

How UITs Operate

The operation of a UIT begins with a sponsor, often an underwriter or brokerage firm, who creates the trust by selecting a specific portfolio of securities. These selected securities are then deposited into the trust. The trust subsequently issues “units” of beneficial interest to investors, with each unit representing a proportional ownership share of the underlying portfolio. This issuance typically occurs during a one-time public offering.

Throughout the trust’s life, income distributions, such as dividends from stocks or interest from bonds, are passed through to unit holders. A trustee oversees the trust’s activities, holding assets and administering the trust according to the trust agreement, ensuring it operates in the best interests of unit holders and handles income and principal distribution. At the specified termination date, the trust liquidates its remaining securities, and the final proceeds are paid out to unit holders.

Distinctions from Other Investment Vehicles

UITs differ from other common investment vehicles, such as mutual funds and Exchange Traded Funds (ETFs), primarily in their structure and management. Unlike mutual funds, which are typically actively managed with portfolios that can frequently change, UITs operate with a fixed, unmanaged portfolio. Mutual funds are also open-ended, continuously issuing and redeeming shares, whereas UITs issue a fixed number of units during an initial offering and have a defined termination date.

ETFs, while often passively managed like UITs, are traded on exchanges throughout the day, similar to individual stocks. UIT units are typically purchased directly from the issuer or through a broker. Although a limited secondary market may exist, the primary way to exit a UIT before termination is by redeeming units with the sponsor. ETFs generally reinvest principal into the fund as securities mature, unlike UITs, which distribute principal to unit holders at termination.

Investing in a UIT

Investors typically purchase UITs from brokers or directly from the sponsor during their initial offering period. While UITs are designed to be held until their termination date, investors can sell their units before maturity. This can be done by selling units in a limited secondary market or by redeeming units with the sponsor at their net asset value. Early redemptions are based on the current underlying value of the holdings, which may be more or less than the original purchase price.

Associated costs for investing in a UIT include sales charges, composed of an initial sales charge and a deferred sales charge. A creation and development fee, often around 0.50%, is also assessed to compensate the sponsor for establishing the trust. Additionally, annual operating expenses cover costs such as trustee fees, administrative expenses, and portfolio supervision. These fees are outlined in the UIT’s prospectus.