Unit investment trusts are investment companies that buy a specific portfolio of stocks, bonds, or other securities. They are cousins to mutual funds, but they have some fairly significant differences, too.
First of all, UITs have fixed terms -- as short as a single year, or as long as 30 years or more. Mutual funds are ongoing operations that never expire.
UITs generally buy and hold a fixed portfolio of stock, bonds, or other securities, often concentrated in a particular industry or sector. This is in marked contrast to mutual funds, which are required to adhere to certain rules of diversification and must hold a minimum number of different securities. UITs are not subject to those requirements, and so can own shares of stock in just a few companies. This is why there are no mutual funds that use a pure "Dogs of the Dow" approach. The "Dogs" strategy entails buying the ten highest yielding stocks in the Dow Jones Industrial Average, holding them for a year, and then repeating the process. Since a mutual fund can't own just ten different companies, a number of UITs have been created to implement the Do
gs of the Dow strategy.
Mutual funds can sell and buy shares frequently as long as those transactions meet the funds objectives stated in its prospectus. UITs cannot purchase or sell securities except in limited circumstances. In the case of one UIT, S&P Depositary Receipts (also known as SPDRs), the trust can replace securities only if they are replaced in the Standard & Poor's 500 Index -- and for no other reason.
Another difference between a trust and a mutual fund is that a trust doesn't generally generate capital gains to distribute to shareholders. Because the number of shares available in a UIT is fixed when the trust is created, investors who purchase shares in a UIT after its initial offering buy them from other investors, and not from the sponsor, similar to a stock or closed-end fund.
Because of the fixed number of shares of any particular UIT available in the market, buying and selling shares among investors does not carry tax consequences for other shareholders. In a mutual fund, a sell-off by shareholders could cause the fund to liquidate part of its holdings, and generate capital gains in the process. These taxable gains would be distributed to fundholders at year-end. In a UIT, shareholders generally incur capital gains or losses when they buy or sell their UIT shares.
UITs do distribute dividend income to shareholders, either on a monthly or quarterly basis.
There are over 12,000 unit investment trusts currently available in the U.S., each specializing in any of a number of investment objectives. There are UITS that own corporate bonds, international bonds, state or national municipal bonds, U.S government securities, mortgage-backed securities, and equities. Some UITs concentrate on specific sectors, or a particular investment strategy.