When you invest in a traditional mutual fund, the next chapter of the story may be “here today, gone tomorrow.” You might choose a fund that’s posted a spectacular record last year from Internet stocks, only to see returns plunge this year because the sector is out of favor. Or the stock-picking wizard who was running your fund may get an offer he or she can’t refuse and move to another mutual fund outfit, leaving your money in the hands of an unproven portfolio manager.
Increasingly, investors who are leery of such outcomes are turning to unit investment trusts (UITs), which raised more than $75 billion in 1999, according to the Investment Company Institute, a mutual fund trade group in Washington, D.C. With a UIT, securities are bundled together and then sold in pieces to investors, generally for an outlay of $1,000 or less. UITs are unmanaged pools, meaning that the securities are unchanged throughout the life of the trust.
With stocks enjoying a 10-year bull run, investors have increasingly turned to equity UITs, where a group of stocks is selected for a buy-and-hold strategy. Some equity UITs are based on a particular investment strategy or on an industry sector (See “ABCs of UITs,” Moneywise Online, current issue).
Regardless of the type of equity UIT, the stocks are generally held for the term of the trust, typically from one to five years. During that time, values are set daily and investors can sell their units, if they wish.
When the trust matures, investors can cash in or “roll over” and invest in a new trust. Either way, you’ll incur tax consequences. If the trust has increased in value, there will be capital gains; such gains will be long-term because virtually all of the trusts are designed to last more than one year. Dividends are taxable, too, whether the cash is distributed or reinvested in additional units.
“If investors roll over into a new trust, and many of the same stocks are in that trust, taxes can be deferred on those companies,” says Timothy Mahoney, chief investment officer with Defined Asset Funds in Princeton, New Jersey. “The sponsors will help with the tax-reporting paperwork.”
In some UITs, investors have yet another option: when the trust matures they can receive shares of each stock in the portfolio, which will defer the tax consequences until the shares are sold. This distribution option may be limited to investments over a certain size, for example, $10,000.
Adherents say that the equity UIT format offers an important advantage over typical mutual funds: a stable portfolio.
“There are no worries about turnover among portfolio managers,” says Glenn Caldicott, a Boston-based financial advisor affiliated with The Advest Group. “You won’t see an equity unit trust switching 30% of its portfolio into bonds, gambling on a decline in interest rates, but that has happened with leading equity mutual funds.”
As for costs, a typical equity UIT has a 2.75% front load fee. After that, the initial load is 1.75% on a rollover or a switch to another