Unit Investment Trust

A unit investment trust (UIT) is a type of investment vehicle where investors pool their money to purchase a fixed portfolio of stocks, bonds, or other securities, with a set end date.
Unit Investment Trust (UIT)
3 min
28-June-2024

Investing is one of the most vital factors in a successful financial plan. It allows your savings, which you would otherwise keep in a savings account, to multiply and provide hefty returns. However, when it comes to investing, the process seems complex as investors have to identify and analyse stocks extensively based on technical and fundamental factors. This may discourage some investors who are not well-versed in the analysis process.

Although numerous investment instruments exist for such investors, such as mutual fund schemes, they can also look toward alternative investments, such as UITs. This blog will help you understand What is a UIT and how it can help you diversify and earn good returns.

What is a Unit Investment Trust (UIT)?

A unit investment trust is an investment company in the United States that buys and holds various securities, such as stocks and bonds, and allows investors to invest in them as redeemable units. Redeemable units are investment units issued by certain types of funds that pool investor money. Investors can redeem (sell) these units at any time to realise cash.

Similarly, UITs buy numerous investment instruments and make them available to investors as a fixed portfolio. They work similarly to a mutual fund scheme where investors can invest a specific amount and get proportional ownership in various securities included in the fixed portfolio.

Also read about: SIP investment

Understanding unit investment trusts with an example

A unit investment trust is a fixed portfolio offering where investors can invest and earn through dividend income and capital appreciation of all the included securities. A UIT works similarly to open-ended and close-ended mutual funds as they include a basket of investments rather than investing the whole amount in a single security. As an investment company, UIT buys various securities, such as stocks, bonds, mutual funds, ETFs, etc., and creates a defined portfolio by adding all the securities bought in a predefined proportion. When investors invest a specific amount, the amount gets invested in all the included securities as per the pre-defined proportion.

However, unlike mutual funds, UITs have a set expiration date based on the investments held in the fixed portfolio. When the portfolio expires, the investors receive a portion of UIT’s net assets based on the amount they have invested. Furthermore, as the portfolio is fixed, it isn’t actively managed and remains the same throughout its tenure.

Here is an example.

  • Initial investment: Rs. 1,020
  • Quarterly dividends received over 10 years: Rs. 50 x 4 x 10 = Rs. 2,000
  • Final distribution: Rs. 1,500
  • Total returns: Rs. 3,500 (Rs. 2,000 + Rs. 1,500)-Rs. 1,020 = Rs. 2,480

In this example, the investor benefits from the stable income provided by the high-dividend stocks and the potential capital appreciation of the portfolio over a 10-year period.

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Types of unit investment trusts

Here are the types of unit investment trusts:

1. Income funds

Income funds create a fixed portfolio of securities that aims to deliver regular income through dividend payouts rather than focussing on capital appreciation.

2. Strategy funds

Strategy funds aim to beat market benchmarks, such as Nifty, Sensex, etc., or the whole market in general. They rely on extensive fundamental analysis to identify investments that can provide better returns than benchmarks or the whole market.

3. Sector-specific funds

Sector-specific funds identify and add securities in the portfolio that are specific to a sector. Although risky, they may generate good returns if the sector performs well.

4. Diversification funds

Diversification funds focus more on diversifying by including a host of securities with the aim of lowering the overall risk. These funds mitigate the associated risk but may fail to provide high returns.

5. Tax-focused funds

Tax-focused funds aim to reduce individuals' tax liability by investing in tax-efficient securities. Their main focus is tax-saving and not providing hefty returns.

Also read about: How to Choose Mutual Funds

How does a unit investment trust work?

A unit investment trust works by buying a host of securities, such as equities, bonds, mutual funds, etc., and holding them for a specific time. Investors can invest a specific amount in a UIT, which gets invested in all the securities added to the portfolio as per the predefined investment proportion. UITs are not actively managed, and the investments remain unchanged throughout the tenure. Because of this, UIT investors receive steady and predictable returns suitable for their risk appetite and investment goals.

When investors invest initially, they must pay according to the UIT units' net asset value (NAV) plus applicable sales costs. Unit holders get regular returns from the UIT in the form of interest or dividend income. The UIT expires after the trust’s expiry date, and the remaining securities are liquidated, with the proceeds going to the investors according to the number of their units.

Advantages of UIT

Now that you know what UITs are, let us look at their advantages. Here are the pros of UITs:

  • A unit investment trust provides investors with effective diversification as they can invest in a wide range of securities. Diversification minimises the risk level for the investors as the risk gets spread across numerous investments.
  • UITs provide the utmost transparency to investors. They are required to disclose their fixed portfolios regularly so investors can see the amount and proportions they have invested. Another advantage is the absence of active management, which reduces the overall cost of UITs compared to other actively managed funds.
  • Unit investment trusts have a low minimum investment requirement, which makes them affordable and accessible for beginner investors. Since the portfolio is fixed, investors know beforehand the profit potential and the income they stand to earn.

Also read about: How to calculate the NAV of a mutual fund

Disadvantages of UIT

Now that you know what UITs are, let us look at their disadvantages. Here are the cons of UITs:

  • Investors have little to no control over their investments as UITs are not actively managed, and the portfolio remains unchanged throughout the tenure. Hence, investors stand to make losses if investments turn negative as there is no adjustment or strategy change, even if the investments are falling in price.
  • UITs provide diversification but may fail to provide high returns to investors as the investment strategy is focused more on providing low-risk, steady returns. Also, the diversification is limited compared to other diversified investments.
  • Unit investment trusts invest for the long term, which makes them inappropriate for investors looking to book short-term profits. Furthermore, it is difficult to invest in UITs as they are not traded on stock exchanges like mutual funds, which also lowers the liquidity.

What is the primary benefit of a unit investment trust?

The primary benefit of investing in unit investment trusts is the predictable nature of the income and interest. Since these trusts are not actively managed and remain unchanged throughout the tenure, they provide stability to investors as they know how much they are going to earn and how much tax they will be liable to pay.

Additionally, individuals invest in UITs because they can pay regular income from dividends or interest, providing a steady income source without much risk. The low turnover in UITs also contributes to tax efficiency, as investors end up realising fewer capital gains compared to actively managed funds.

Also read about: How does mutual fund work

How unit investment trusts are sold?

One important factor in understanding what is UIT investment is to learn about how UITs are sold. UITs are created as a fixed portfolio, including numerous securities in predefined proportions. Once created, a single portfolio is sold as a unit to the investors. When they invest, the money gets distributed and invested in all the securities as per the weightage of every included security.

Similar to mutual funds, units are also sold to investors based on net asset value (NAV). Investors can buy these units through a financial advisor or a brokerage firm.

Also read about: How to calculate capital gains tax

What Is the main risk of a unit investment trust?

The main risk of UITs is their lack of flexibility in the fixed portfolio. Once the portfolio of securities is set, it generally remains unchanged for the duration of the trust, which can range from a few months to several years. This fixed nature means that UITs cannot adjust investments in case investments fall in their prices or the market turns negative. Additionally, since the trust is not actively managed, there is no opportunity to replace underperforming securities, which can lead to potential losses.

Also read about: Asset management company

Unit investment trust vs Mutual funds

Unit investment trusts seem similar to mutual funds but differ in certain aspects. These are:

End dates

Unit investment trusts have end dates. This means that after a specific time, they expire, and investors receive their principal amount back. On the other hand, mutual funds are open-ended funds, where the portfolio manager can buy and sell securities at any time for adjustment or redemption.

Number of shares

Unit investment trusts issue a fixed number of shares during their initial offering period, and no additional units are created afterwards. Investors can buy or sell these units in the secondary market, but the total number of units remains constant until the trust expires. On the other hand, mutual funds continuously issue and redeem shares based on investor orders, which continuously changes the number of shares in the portfolio.

Level of activity

The activity level in UITs is not aggressive as the securities are bought upfront and held for the duration of the trust. However, mutual funds aim to track or outperform the underlying benchmark, and the portfolio manager constantly buys or sells securities to match the investment strategy.

Taxations of unit investment trusts

Unit investment trusts are pass-through investments, meaning the investor’s tax liability is shared. Hence, income, losses, and gains are passed to the investors, who are responsible for filing taxes as per their applicable tax slabs.

The tax treatment for UITs differs based on the type of securities held by the investors in a specific UIT portfolio. For example, if a UIT has paid a dividend, the investors are liable to pay tax on the dividend income. On the other hand, if the UIT is tax-saving, the tax treatment will be different per the provisions of the Income Tax Act of 1961.

UIT costs

Similar to mutual funds, Unit Investment Trusts also have costs such as load and sales charges. These charges are generally based on a percentage of the total amount invested by the investor, ranging from 1-5%.

UITs also charge an annual management fee as a percentage of the total assets held in the UIT. It covers the cost incurred by the UIT in managing the portfolio. However, this cost is lower as UITs are not actively managed.

Another charge is the trustee fee, which covers the costs of various trustees who oversee the UIT. These costs are a percentage of the trust assets or a fixed amount.

Also read about: What is investment management

Conclusion

Unit investment trusts are US-based investment companies that sell UITs as alternate investment instruments. They buy securities, add them to a fixed portfolio, and sell them as units to investors. Investors can invest in UITs to earn regular income and interest without taking on much risk. They are somewhat similar to mutual funds but differ in certain factors. Now that you know what is a UIT, you can consider adding them to your portfolio along with other instruments, such as mutual fund schemes.

If you are considering investing in mutual funds, you can visit the Bajaj Finserv Platform, where you can use unique tools, such as mutual fund calculators, to compare mutual funds and invest in the most suitable schemes.

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Frequently asked questions

Is a UIT a mutual fund?
No, a Unit Investment Trust (UIT) is not a mutual fund. UITs have a fixed portfolio of securities and a defined expiration date, unlike mutual funds that continuously issue and redeem shares and have actively managed or index-tracking portfolios.
What type of investment is a UIT?
A unit investment trust is an alternate investment that pools investor money to buy securities and create a fixed portfolio. Investors can invest, earn from dividends or interest, and get their money back when the trust expires.
What are the benefits of UIT?
The benefits of UITs include predictable income, diversification, lower risk, low costs, and steady long-term income.
Who can sell UIT?
UITs can be sold by financial advisors, brokers, and financial institutions that are licensed to sell securities.
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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.