A unit investment trust or UIT is a pooled fund that is structured as an investment company and pools money from investors to have a larger capital for investing in stocks and bonds. Hence, similar to other pooled funds, it benefits from economies of scale to create a basket of investments composed of different securities. The main difference between a UIT and other retail-focused pooled funds like mutual funds and exchange-traded funds is that the portfolio is fixed. This means that it is unmanaged and its composition will remain unchanged. Investing in UIT provides several advantages but interested investors must also be aware of its disadvantages.
Pros of Unit Investment Trusts: Notable Advantages of Investing in UIT
The core advantage of unit investment trusts is that they provide a solution for investors to invest in a diversified and professionally selected portfolio of securities without the need for active management. These advantages are shared with other pooled funds. The following are their more specific and inherent advantages:
1. Professional Fund Management
Remember that these funds are unmanaged. However, when it comes to the selection and allocation of investments, teams of experienced professional fund managers are responsible for selecting the vest securities or assets to include in a particular fund. This lessens the need for novice investors or even seasoned investors to spend time researching and analyzing which securities and assets to include in their investment portfolios or how much they should allocate.
2. Buy and Hold Investment Strategy
Another advantage of investing in unit investment trusts is that they are suitable for a buy-and-hold investment strategy in which the purchased securities are held for an extended period to maximize capital appreciation. This strategy eliminates the impact of emotions and reactions. It is suitable for individuals with a fixed and long-term investment time horizon. This also makes UITs an ideal alternative to savings because of their higher potential for growth.
3. Diversification and Fund Selection
A particular UIT is invested in different securities. This means that an investor needs only a single account and a single transaction to have a diversified investment. There is no need for them to research and analyze individual securities or build a diversified portfolio over time. There are also different funds to choose from. Each has its investment objectives and strategies that can be aligned with the objectives, risk profile, and time horizon of individual investors.
4. Affordable and Accessible Investment
These investment products are sold by banks and investment firms. Opening a UIT account is as simple as going to a provider, filling out several forms, signing, and paying. Most providers transact through an online-enabled platform. An individual can open an account for as low as USD 50 to USD 100. This makes it one of the most affordable investment options out there. It also has lower costs than actively managed mutual funds and exchange-traded funds.
5. Defined Maturity and High Liquidity
Another advantage of a unit investment trust is that it has a defined maturity. This usually ranges from 15 to 30 years. This makes it ideal for long-term investing. The portfolio is then liquidated and the proceeds are distributed to the investors. There is an option to reinvest in another vehicle. A UIT is also liquid. An investor can redeem a portion of his investment through unit cancellation. There are UIT funds that provide a predictable stream of income.
Cons of Unit Investment Trusts: Key Disadvantages of Investing in UIT
However, despite the convenience, a core disadvantage of investing in unit investment trusts is the absence of control. This is true for all pooled funds. Furthermore, because of their fixed portfolios, investment growth is limited compared to pooled funds with managed portfolios. Below are their specific and inherent disadvantages:
1. Limited Investment Growth Prospect
The main disadvantage of unit investment trusts is that they have a limited potential to maximize investment growth compared to other pooled funds. This comes from the fact that they have fixed and unmanaged portfolios. The composition of these portfolios remains unchanged for the most part. This makes them unable to adapt to changing market conditions. Underperforming securities can also temper the gains stemming from better-performing ones.
2. Lack of Control Over Investments
Furthermore, related to the aforementioned limited investment growth prospect, it is important to reiterate the fact that one of the main disadvantages of pooled investment vehicles like UITs is that investors cannot influence the direction of the portfolio. The fund managers are responsible for selecting the securities and assets in a particular UIT fund. This means that investing in UIT is akin to trusting the capabilities and decisions of these fund managers.
3. Dilution and Termination Potentials
Another drawback of investing in UIT is that investors are exposed to either dilution risk or early termination risk. Dilution happens when a sizeable number of investors redeem their units before maturation and the fixed operating investment of the trust is spread among the remaining units. Furthermore, if the entire trust is terminated before its maturity date, investors would lose the potential gains from a long-term buy-and-hold investment strategy.
4. Exposure to Other Types of Risks
It is important to underscore the fact that all investments come with risks. This is true for UITs. The risks of UITs depend on the composition of their portfolios. Those that are invested in equities are exposed to the risks of stock investing. Those who are invested in bonds are exposed to the risks of bond investing. There is also the potential for investors to lose a portion of their capital during periodic market downturns or severe economic slumps.
5. Potential Reinvestment Inflexibility
A reinvestment risk transpires when a particular investor, upon receiving the proceeds from his or her investment, is unable to reinvest it because the market prices are unideal, either because the interest rates have become low or the price of the security has become too high. This problem is exacerbated if the fund matures at a time when the market is unideal or when the performance of its portfolio has been suboptimal and below the expected returns.
Special Pointers: Pros and Cons of Investing in Unit Investment Trusts
The aforementioned advantages of unit investment trusts make them suitable for individuals who want a diversified portfolio or add another investment to their portfolio and prefer a hands-off approach to investing. These investment vehicles can be appealing to conservative investors with a longer investment time horizon. It is also important to keep in mind the selection of funds when investing in unit investment trusts and make sure that the selected funds are aligned with the goals and objectives, risk profile, and investment time horizon of a particular investor. The disadvantages discussed above should also be factored in. Remember that the limited investment growth prospect and longer time horizon might not be suitable for people who want to generate substantial returns either in the short term or long term.
