What the heck is a Unit Investment Trust?

We're all familiar with open-end mutual funds because they've been marketed quite successfully by household names including Fidelity, Vanguard, Janus, and American Funds. With UITs or "Unit Investment Trusts," few people seem to be familiar. I like to think of it this way--eventually, I'm going to want to devote a serious percentage of my investment capital to fixed-income. I don't need the ultra-safety (and low yields) of US Treasuries, and since most of my investing is still done in a retirement account, I shun municipal bonds, as well. I need corporate bonds, but I can't buy the things outright without devoting say $100,000 per issue. And, I don't want to be exposed to just two or three issuers. So, I need a portfolio. I don't necessarily need an investment adviser trading that portfolio, however. If I don't want to pay management fees and don't necessarily believe that an actively managed portfolio of bonds will outperform an un-managed portfolio, I buy a unit investment trust as opposed to an open- or closed-end mutual fund. I figure the trustee will oversee/supervise the portfolio and only charge minimal fees to administer the trust. The rest of the income gets paid pro rata to us unit holders, and we can redeem our units for whatever they happen to be worth at the time. Many UITs are a portfolio of preferred stock, and that might be even more to my liking. Hold these in the taxable account and enjoy qualified dividends plus a well-diversified portfolio of fixed-income securities I'm too lazy to buy or manage myself. More Help

Open and Closed-End Funds

Wow. Didn't mean to neglect the Pass the 7 blog, but I haven't posted since flippin' February. Not accpetable. Let's start making up for it right now with a fun practice question . . .

Open- and closed-end funds share none of the following characteristics except that:
A. open-end funds must be "diversified" according to the 75/5/10 rule
B. closed-end funds must be "diversified" according to GAAP accounting rules
C. closed-end funds are non-redeemable investment company securities
D. open-end funds may issue preferred shares

EXPLANATION: once again, a mildly confusing topic can become massively confusing if the question is written a certain way. Oh well. Take a deep breath, look at the question from a different angle, and proceed to kick its butt. Do open-end funds have to be diversified? Heck no--it's just that if they want to call themselves "diversified," they have to follow the SEC rule. Closed-end funds don't have to be diversified, either, and even if they did "GAAP Accounting" is nonsense . . . so you can now eliminate the first two answer choices. Boom. See anything wrong with Choice C? Me neither, but let's not make our move too soon. What about D? Isn't it the CLOSED-end fund that might issue preferred shares to use leverage? Yes. D is false. The answer must be . . .


ANSWER: c

Closed-end funds

Closed-end funds are exactly the same as open-end funds, only completely different.
Let's look at the similarities:

• both are portfolios managed by an investment adviser
• investment objectives are often similar
• both are investment companies
• both are "management companies" as opposed to UITs and face-amount certificates

Now let's look at the differences:

• open-end funds are redeemed for the NAV (net asset value)
• closed-end funds are traded, independent of their NAV
• sales charges and 12b-1 fees are charged to open-end fund investors
• investors pay commissions to buy and sell closed-end funds
• closed-end funds use more leverage offering auction-rate preferred shares to investors
• open-end funds may continuously offer new shares
• closed-end funds have a fixed number of shares

Closed-End Funds

As usual, I'm visiting the FINRA website on a Friday morning looking for recent regulatory actions. This morning I see an action against a couple of large firms concerning the fact that an IPO for a closed-end fund has a built-in sales charge (like any IPO) and, therefore, customers should not be advised to buy them during the offering and then dump them in the short-term. If you click on the link below you'll see how FINRA deals with such matters--they fine people, put them in the penalty box, and name names and reveal CRD numbers. In other words, it's a good idea to stay out of trouble. Check out the disciplinary action below. Once again you'll see how "real world" this Series 7 information actually is:

http://www.finra.org/Newsroom/NewsReleases/2009/P119457