The Often Overlooked Unit Investment Trust

Most Exchange-Traded Funds (ETFs) are set up as unit investment trusts that are only redeemable into large "creation units" by the broker-dealers who sponsor them. Everyone else trades the shares, which seek to mimic the performance of a particular index. That's all well and good, but the UIT that intrigues me is the fixed portfolio of preferred stock or bonds that has no investment adviser and, therefore, no management fee. A portfolio of, say, 50 preferred stock issues is purchased and placed in trust overseen by the trustee, who pays out the income produced by the securities in the portfolio after trustee and administrative fees have been deducted. Your exam might refer to such a UIT as a "supervised, non-managed portfolio, typically of fixed-income securities." That's exactly what it is, and since I'm pretty sure that trading in and out of preferred stocks is both expensive and unnecessary, I see no reason to pay an investment adviser to manage/trade the portfolio.
So, what's stopping me? Interest rates. Yields are still so low at this point that I can't get excited over parting with a large chunk of change just to watch 2-3% yields dribble in. I've told myself that when I can get a 5% yield or higher, I will start buying in. As your test wants you to know, my risk is that interest rates will keep climbing after I buy in--the value of my units will drop if that happens. Then again, I would still be collecting a decent yield from preferred stock, and I can check the credit quality of the issues and let the trustee handle it from there.
A likely test question on a UIT would point out that these securities are primarily regulated under the Investment Company Act of 1940.Need Help with your Series 7?

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

Unit Investment Trusts

Under the Investment Company Act of 1940, there are three types of investment companies: face-amount certificate companies, unit investment trusts, and management companies. The two management companies are generally managed actively by a portfolio manager. The difference is just that you redeem the open-end shares for the NAV while you have to sell your closed-end shares for whatever the market will give you, often a discount to the NAV. The UIT (unit investment trust), unlike the open-/closed-end funds, is just a fixed trust of income-producing securities. It holds bonds or preferred stock usually, and the investors holding units earn a fixed stream of income until the trust is terminated, the unit values paid out to the unit holders. If interest rates rise, unit values will drop in value, but the income that the trust earns will stay the same. In a management company (open- or closed-end fund), the portfolio manager could take advantage of a rise in interest rates by buying new bonds paying higher yields. A UIT, however, is not managed. The investments are selected. Often the bond portfolio would terminate when all the bonds mature. Preferred stock, which is generally perpetual, would only be turned into cash if it were called by the issuer.

I'm not sure that UITs will make much of an appearance on the Series 7, but they're on the outline, and, therefore, you could easily see one or two questions. As always, you have to know just enough information about a vast array of topics to pass the Series 7 exam.