Think of a mutual fund that buys a group of stocks or bonds and keeps them for a year or some other period, then terminates the fund and pays off the shareholders.
That's the basic definition of a unit investment trust.
If you are a customer of a full-service brokerage firm, you are likely to have been offered a chance to invest in one or more trusts, because most unit trusts are sold by brokers. The trusts often have intriguing themes and low ongoing expenses, but critics argue that they cost too much to buy (or sell) and that their short-term nature runs against the wisdom of a long-term, buy-and-hold investment style.
Although they have existed for decades, unit trusts are a mystery to many investors. You don't see a lot of advertisements for them, you can't find many of their share prices listed in newspapers and you can't find much research about them. Yet there are a lot of unit trusts out there--nearly 11,000 as of the end of 1998, making them more numerous than mutual funds, reports the Investment Company Institute, the mutual fund industry's chief trade association. But each trust is small, and the amount of money in unit trusts is minuscule. Combined, they accounted for just $95 billion at the end of last year, according to the ICI. That's a fraction of the $5.5 trillion invested in mutual funds at the time.
Unit trusts, like funds, are diversified portfolios of stocks or bonds handpicked by professional money managers. Both investments are regulated by the Securities and Exchange Commission and, in many cases, by the National Assn. of Securities Dealers.
Unit trusts cover many strategies. "There's enough variety in terms of investment portfolios that you can appeal to almost anyone," said Doug Rogers, executive vice president at Ranson & Associates, a trust sponsor in Wichita, Kan.
But there are key differences between trusts and funds. In particular, trusts don't receive ongoing investment management. A sponsoring firm will put together a portfolio, then let the stocks or bonds rise and fall without intervention until a trust matures--usually in one to six years but sometimes longer. Sponsors often have a similar trust ready to accept rollover money for people who don't want to cash out--especially if the trust has performed well.
Many unit trusts are heavy on investment concepts or themes. For example, you can invest in stocks likely to benefit from demographic trends through Van Kampen's Roaring 2000s Trust or other baby-boom-economy portfolios.
Alternatively, you can buy into the Best Ideas portfolios from Morgan Stanley Dean Witter, which focus on the favorite stock picks of the firm's research staff. And there are trusts dedicated to health-care companies, Internet stocks and much more. One common theme is the "'Dow dogs" strategy of selecting the five or 10 companies in the Dow Jones industrial average paying the highest dividend yields.
Ranson has an intriguing fund that holds the 100 most "timely" stocks as identified by Value Line.
There's even a unit trust that allows shareholders to invest alongside the super-rich. This Forbes Forty Index Trust from Prudential Securities holds 40 large stocks such as Microsoft, Wal-Mart and Berkshire Hathaway that weigh heavily in the personal holdings of individuals on the Forbes 400 list of wealthiest Americans, including Bill Gates and Warren Buffett.
Major sponsors of unit trusts include most of the big full-service brokerages along with Van Kampen, John Nuveen, Nike Securities and Ranson & Associates.
Bond funds used to dominate the unit trust scene, but now stock offerings have become more popular. At the end of 1998, stock portfolios accounted for 60% of UIT assets, up from 34% just two years earlier.
The lack of active investment management is a double-edged sword. As a positive, it allows unit trusts to shave their operating costs, while providing investors with a clear idea of a portfolio's characteristics.
Yet the lack of active management also means little flexibility, and if one or two stocks or bonds fall dramatically in value, the trust may suffer.
Some trusts hold as few as five stocks. Stricter diversification rules for mutual funds generally preclude that much concentration.
But the diversification issue isn't the major obstacle to unit trusts' popularity. Rather, costs seem to be. Granted, unit trusts feature very low ongoing expenses of just 0.2% to 0.3% a year, on average.
But nearly all unit trusts come with sales charges--typically 1% to 4%--that limit their appeal to cost-conscious investors. You also pay a smaller charge of perhaps 1% to 1.5% to roll assets into a new portfolio upon maturity, as many people do. If there are any no-load unit trusts, I haven't found them.
Also, you don't see the load-paying options that are typically available with mutual funds. In the fund realm, you can choose to pay a front-end load, a back-end charge or perhaps a combination of the two. By contrast, most unit trusts carry both a front-end load and the deferred sales charge that kicks in each year you maintain the account.
You can buy standard unit trusts through discount brokerages, but you aren't likely to receive a better deal than you'd get through full-service firms. One exception is a series of unit trusts featuring Dow dogs stocks and offered by Charles Schwab. These portfolios feature investments in 10 high-yielding Dow stocks and a fairly low first-year sales charge of 1.25%, followed by 1% annual charges in subsequent years.
"Our customers expressed an interest in a dogs of the Dow portfolio, and we felt we could deliver a more cost-effective product," said Greg Gable, a Schwab spokesman in San Francisco.
But while investor response to the Schwab 10 Trust has been respectable, the company hasn't followed that up with new types of unit trusts. Against the fierce competition posed by mutual funds, the trusts can be a fairly tough sale.
Russ Wiles, at email@example.com, is a regular contributor to The Times.