By Jason Zweig | July 19, 2013 6:57 p.m. ET
Image Credit: Christophe Vorlet
While money has been gushing out of U.S. stock funds, unit investment trusts have been raking it in.
These investments—a peculiar cross between mutual funds and exchange-traded funds—have been around for decades. By 2008, they were on their way to oblivion. But total assets of UITs have since nearly tripled, rising last year by 20% to $72 billion, according to the Investment Company Institute, a trade group. New money is pouring in, putting 2013 on pace to be the top-selling year on record.
Are these funds a good deal for investors? That depends on how much of your investment decision-making you want to delegate to your financial adviser. If you want your broker to do most of your thinking for you, then UITs may be cheaper than conventional mutual funds. Otherwise, you can probably do better elsewhere.
Like the Greek mythological creatures that amalgamated different species in the same body, UITs mix elements of mutual funds and ETFs.
The roughly 6,000 UITs, like mutual funds, are priced once a day and typically seek to beat a benchmark or market segment. But like most ETFs, UITs can be bought only through a brokerage firm.
Unlike mutual funds or ETFs, UITs are set in stone: Once the portfolios launch, the managers generally can’t trade. And they terminate on a fixed date, usually after 15 months or two years. On that date, you must either take your proceeds as cash or buy a new UIT.
More than two-thirds of UIT assets are in stocks or closed-end funds that trade like stocks. Many hold bundles of high-yielding assets like dividend-paying stocks, real-estate investment trusts, business-development companies, master limited partnerships and so on.
Annual expenses are low, often 0.25% to 0.3% of assets, or just $25 to $30 on a $10,000 investment. That is a fraction of the 1.3% average on a stock mutual fund and competitive with many ETFs, if you don’t count the higher sales charges on UITs.
By not trading, UITs also avoid the transaction costs — which can exceed 1% annually — that are a silent killer of mutual-fund returns. By the same token, UITs also can reduce any hankering your broker might feel to trade too much.
But UITs carry some heavy baggage, too.
You will have to pay your broker pretty richly. If you are reinvesting from an existing UIT, you will get a 1% discount on the sales fees; you also will get a break if you invest more than $50,000 at a pop. Otherwise the upfront and deferred sales charges on a 15-month UIT, like Brand Favorites Focus Portfolio, launched on July 10 by Advisors Asset Management of Monument, Colo., will cost you up to 2.95% of your investment. A two-year UIT, like Canadian Energy & Income, sold this Wednesday by Guggenheim Investments of Lisle, Ill., will run you as much as 3.95% in sales fees.
While some mutual funds might sometimes charge up to 5.75%, you can buy many ETFs commission-free. “UITs offer the opportunity to outperform rather than just track an index,” says Richard Stewart, a senior vice president at Advisors Asset Management, which oversees $8.3 billion in UITs. “They also offer potentially better diversification.”
“Cheaper is not always better,” says Dominick Cogliandro, head of Guggenheim’s $5 billion UIT operations. “UITs offer a very disciplined approach.”
Comparing UITs isn’t easy. A spokeswoman for Morningstar, the investment researcher, says the firm might “someday” offer comprehensive data on UITs. For now, the websites of the sponsoring firms show each UIT’s total return, but you will have to compare them by hand.
Finally, while many UITs are widely diversified, with dozens of holdings, some are hyperspecialized. A broker who adds more than a few such holdings to your portfolio can end up making a jumbled mess.
AAM’s Global Gold Income Portfolio, launched this Tuesday, sells long-term stock options on 13 gold-mining companies and ETFs. “This is a way of getting gold exposure that potentially limits the upside but provides income,” says Mr. Stewart of AAM.
On July 12, Guggenheim opened a UIT that holds nine closed-end funds that invest in municipal bonds from New Jersey. “You’re getting more diversification by being exposed to more managers,” says Mr. Cogliandro of Guggenheim.
You should be able to meet your income needs more cheaply elsewhere—mainly through index funds or ETFs that hold comparable assets at much lower cost. You could even supplement your investment income by holding an ETF like Vanguard Total Stock Market or iShares Core S&P Total U.S. Stock Market and selling a smidgen of your position in regular increments.
Unless you want your broker to do all your work for you, UITs should probably be a last resort, no matter how popular they get.
Source: The Wall Street Journal