Unit Investment Trusts (UITs)

UITs are commonly associated with mutual funds and closed-end funds due to their similar characteristics. In essence, UITs are pooled investment vehicles investing in a fixed portfolio of securities for a set period of time.

A UIT sells investors shares or “units” in a fixed portfolio of securities through a one-time public offering.  UITs are considered long-term investments that mature on a specific date; generally, after 15 or 24 months. Once the UIT matures, the underlying securities are sold, and the proceeds are paid to investors.

A UIT’s portfolio is passively managed between the trust’s inception and its maturity date. UIT sponsors often offer UIT product lines in successive “series.” These new series coincide with the maturity date of prior series. Successive series of UITs tend to have the same or similar investment objectives and investment strategies as the prior series, despite a change in the underlying securities that make up the fixed portfolio.

Investors can expect to pay various upfront sales charges and fees in a typical 24-month UIT, including an initial sales charge, a deferred sales charge, a creation and development fee (C&D fee), and a fee for annual operating expenses. Investors who own UIT units in an advisory or fee-based account are also generally subject to an annual fee. This fee may be based on the account size, the type of fee-based account, the securities within the account and other factors.

A broker recommending the sale of a customer’s UIT before its maturity date and who then uses the sale proceeds to purchase a new UIT would cause their customer to incur greater sales charges than if the customer held the UIT to maturity. As a result of their long-term nature, structure, and costs, short-term trading of UITs may be unsuitable.

UIT’s charges may create a set of trading risks for investors, particularly if investors receive a recommendation to sell before the UIT’s maturity date and roll over that investment into a new UIT. This causes the investor to incur increased sale charges over time, raising suitability concerns. Because of the long-term nature of UITs, their structure, and up-front costs, short-term trading of UITs may be improper and unsuitable. UIT transactions generate sales charges for a broker-dealer through either:

• Transactions in which UITs are sold before their maturity dates, and customers use some or the entire proceeds for early rollover purchases into new UITs; or
• Transactions in which UITs are sold before their maturity dates, and customers use some or the entire proceeds for series-to-series early rollovers (i.e., purchasing a subsequent series of the same UIT).

Generally, firms must adequately supervise registered representatives for potentially unsuitable short-term trading in long-term investment products such as UITs. Firms must also establish and maintain a supervisory system, and establish, maintain, and enforce Written Supervisory Procedures (WSPs). Firms’ WSPs must be reasonably designed to achieve compliance with FINRA’s suitability rule as it pertains to early rollovers of UITs. Firms’ systems, including automated trade surveillance systems which generate alerts for potential unsuitable trades, must be reasonably designed to detect unsuitable UIT switches.

Improper UITs switches carry significant up-front costs for investors. In addition to supervisory violations, firms may run afoul of FINRA rules by providing inaccurate information to customers related to incurred rollover costs.

It is important for investors considering UIT investments to understand the UIT participants involved in its creation and the services they provide.

• UIT Sponsor: The sponsor is generally an SEC-registered investment bank or broker-dealer registered. It organizes the UIT and establishes its investment objectives. The sponsor also serves as its principal underwriter. 
• UIT Trustee: The trustee is responsible for possession and maintenance of the UIT’s assets. This includes maintaining records of ownership, reporting to UIT holders and ensuring that UIT’s expenses are paid.  The trustee receives a fee for its services, often based upon the total value of the UIT. 
• UIT Evaluator: The evaluator values the UIT’s portfolio for pricing during any of the following stages: 1) the initial offering period, 2) time of redemption, and 3) secondary market sales. The evaluator receives a fixed annual fee based on the UIT’s size or a fixed fee per evaluation. The UIT evaluator may be an affiliate of the UIT sponsor.

UITs are subject to SEC regulation. A UIT issues redeemable units, meaning that the UIT will buy back an investor’s units at their approximate net asset value (“NAV”). Often, UIT sponsors will also maintain a secondary market allowing investors to buy and sell UIT units at the market price.

Throughout its term, a UIT may distribute its income through dividends and interest payments, which can occur monthly, quarterly, semi-annually or at termination. At the UIT’s termination date, investors can receive cash equal to the NAV of the units. Investors can also roll the current value of their investments into another UIT at a reduced sales charge. In some circumstances, investors can receive an in-kind distribution of the UIT’s portfolio of securities.

Investors should be aware that a UIT does not have a board of directors, corporate officers, or an investment adviser to render advice during its life.

UITs may be appealing to investors for several reasons. They employ a “buy and hold” strategy. In other words, UITs will typically maintain their original investment portfolio despite short-term market fluctuations. Accordingly, they are appropriate for investors seeking a long-term investment strategy.

UITs also provide transparency of holdings, fees and concessions. UIT assets will be listed in its prospectus and may include stocks, bonds, preferred stock, ADRs, real estate investment trusts (“REITs”), master limited partnerships (“MLPs”), closed-end funds (“CEFs”), exchange-traded funds (“ETFs”) or other investments. In fact, UITs concentrating in securities of issuers in a particular industry or a group of industries must disclose that concentration in its principal investment strategy, as well as include applicable risk factors in the prospectus.

UITs are liquid investments and investors may redeem their units on any business day at the redemption price. However, each UIT has different investment objectives, investment strategies, and portfolios, and may be subject to different risks, fees and expenses.