It is a bit hard to draw the difference between unit investment trusts and mutual funds for novice investors or those who do not have a foundational understanding of what pooled funds are. These two are among the most common types of pooled funds available for individual or retail investors. They are based on the same concept of leveraging economies of scale and collective purchasing power by pooling money to create a diversified portfolio of investments. However, when it comes to deciding which of the two to invest in, it is important to note that unit investment trusts or UITs have defining characteristics that provide them with advantages and disadvantages that are different from the characteristics or pros and cons of mutual funds.
The Key Characteristics of Unit Investment Trusts
1. Fixed Portfolio
One of the main characteristics that set unit investment trusts apart from pooled funds like mutual funds and exchange-traded funds is that it is established with a fixed portfolio of securities or assets. The composition of the portfolio is based on the decisions of the fund managers and is aligned with the investment objectives of a particular UIT fund. This means that the portfolio will remain unchanged throughout its duration or lifespan except in situations when the company files for bankruptcy or due to a merger or acquisition.
2. Registered Company
It is also important to note that a UIT is both an investment product and a company in the United States that is registered under the Securities and Exchange Commission and is classified as an investment company. The general structure of UIT is defined by the Investment Company Act of 1940. However, in other countries, a single company or bank can offer multiple UIT products called unit investment trust funds. These funds are similar to mutual funds but have defining characteristics similar to UITs in the United States.
3. Passive Management
Take note that mutual funds and exchange-traded funds are either actively managed or passively managed. The difference between active management and passive management is that the former involves regular reconfiguration of the portfolio while the latter has a fixed portfolio and adheres to the principles of a buy-and-hold investment strategy. All unit investment trusts are passively managed. Remember that they have fixed portfolios. This means that their portfolios are not actively managed or rebalanced throughout their lifespan.
4. Unit Ownership
Another characteristic of unit investment trusts is that the amount of investment and proportional ownership are represented by units. This means that an investor buys units when investing in a UIT. These units are not tradeable in an open market but are redeemable. Their price is based on the performance of the portfolio. Investors can sell their units back to the trust in case of partial or full withdrawal. This is called unit cancellation or redemption. Investment and ownership in mutual funds and exchange-traded funds are represented by shares.
5. Defined Maturity Date
A particular unit investment trust has a predefined termination date that is typically set between 15 years and 20 years. This represents its entire lifespan. Mutual funds and exchange-traded funds do not have maturity dates. Investors remain invested in these pooled funds for as long as they like and as long as their providers exist. The set maturity date of a UIT means that it will be dissolved once it reaches maturity. The remaining assets will be distributed among the remaining unitholders or investors. This feature can either be a pro or a con.
6. Limited Flexibility
It is important to reiterate that unit investment trusts have fixed portfolios and set maturity dates. These investments are created with specific investment objectives and strategy and a set lifespan in consideration of passive management. These make them unable to adapt to changing market conditions. Furthermore, unlike the selection of funds in mutual funds and different types of funds in exchange-traded fund vehicles, the selection of or variations in funds in the entire UIT market tend to be limited or not as wide-ranging. Most are even generic.
