Dear Mr. Market:

Have you ever bought a product or service and afterwards felt like you had been taken to the cleaners? Consumers look for superior products and they also want a great deal. Imagine buying a top of the line computer only to find out that you need to buy another one every year or two and to top of it off you have to pay a commission to the salesperson each time…who would possibly want that scenario?!

It might be a very nice computer but at what point do you question your purchase and stop the sales/commission cycle? As we’ve discussed in several of our letters to Mr. Market the financial services industry is littered with products and services that do little for the individual investor but benefit companies and commission driven brokers by lining their pockets. We’ve covered annuities, life insurance products and loaded mutual funds, but today we will look at a product that is making a come back after declining in popularity over the last few years….Unit Investment Trusts or UITs.

The name itself sounds a bit intimidating but the product itself is fairly simple and easy to understand. Essentially a UIT is a fixed unmanaged portfolio with a set maturity in the future (usually one to two years). They are comprised of equities, bonds or a combination of the two with a focus on broad market, specific strategies or sometimes sector specific. At first glance they appear very similar to a mutual fund or ETF (Exchange Traded Fund) but when you pull back the covers the differences are glaring. 

If we go back to our computer scenario just imagine that you invest in a product that sounds very promising only to find out that it will expire or mature every one to two years? That is exactly what happens with Unit Investment Trusts. When they are purchased they consist of a fixed number of stocks and/or bonds and these holdings never change over the life of the investment. When the investment matures the investor has the option to roll the proceeds into the next UIT or take their cash and move on (almost like a CD at a bank). Essentially they provide a new sales opportunity for a financial professional every few years. We can’t help but question if a UIT is a better fit for the investor or for the individual selling the product?

Think about it for just a moment … what professional wouldn’t like to have their business roll over and generate new income every 12 to 24 months?! For financial service professionals that generate their income through fee and commissions, UITs are an ideal product as they allow them to essentially annuitize their business. Transaction charges ranging from 3% to 5% are common and there are additional annual expenses associated with many of the products available.

According to the Investment Company Institute (ICI) there has been incredible growth over the last several years with Unit Investment Trusts. At the end of 2008 there was approximately $28 billion in UITs, that number grew over 200% to $87 billion the end of 2014! While there certainly are some quality UITs available an educated investor can’t help but question what is driving these results when you break down fees compared to other comparable products…

Let’s take a look at three investments that offer broad exposure to Large Cap equity positions:

UIT – Unit Investment Trust

S&P Target 24 : 24 fixed positions in various sectors/industries. 2 year investment. Sales charge and fees = 2.95%

Mutual Fund

Vanguard 500 Index Fund : 505 positions. No maturity – changes made when there are changes in S&P 500. No sales charge, yearly expense ratio = .17%

ETF – Exchange Traded Fund

iShares Core S&P 500 : 502 positions. No maturity – changes made when there are changes in S&P 500. No sales charge, yearly expense ratio = .07%

Often the argument is made that a Unit Investment Trust allows investors to gain exposure to strategies they otherwise would not have had access to. With the changes in the investment world over the last decade this statement simply does not hold water. A very popular UIT has been the ‘Dogs of the DOW’, this strategy invests in the ten highest yielding stocks of the Dow Jones Industrial Index (DJIA). A popular product that utilizes this strategy is the ‘Dow Target 10’ offered through First Trust. On page 4 of their prospectus they lay out the various fees that can add up very quickly! Below is a brief summary:

Maximum Sales Charge

Initial Sales Charge = 1.0%

Deferred Sales Charge = 1.45%

Creating and Development Fee = .50%

Total Maximum Sales Charge = 2.95%

Organizational Costs

Estimated = .20%

Estimated Annual Trust Operating Expenses

Supervision, bookkeeping = .06%

Trustee Fee and other expenses = .094%

Total = .154%

An investor that put $10,000 into this UIT would pay $330 or 3.3% when all the fees were added up. If an investor wanted to implement this strategy themselves, they could buy the same ten stocks and pay around $100 in commission (10 stocks at an average commission of $10) to build it out and then another $100 to sell all of the positions, so all in, it would cost ~$200. For comparison reasons the Dow Target 10 UIT is also offered by First Trust, and they offer a similar strategy as an ETF with a fee of .51%.   What investor would choose to pay nearly 2.8% more for the same investment offered from the same company? In our opinion the investor is not making this decision, but rather it’s typically the financial professional looking to maximize their income.

Other key points to keep in mind…. 

Taxes – Investors have little to no control over tax ramifications associated with Unit Investment Trusts if purchased in a taxable account. The investments are purchased when the UIT is created and sold at maturity.

Liquidity – UITs can be sold prior to their maturity but this can be difficult and the market is limited. Investors should plan on leaving the funds in the product until it expires.

Monitoring – It can be challenging to monitor the performance of many UITs. They price like a mutual fund based on the price of each holding at market close. Many of the well-known research firms like: Morningstar, Lipper, Value Line and the Wall Street Journal do not follow or publish ratings or performance of UITs.

Expenses – We don’t want to beat a dead horse but investors need to research and understand what other options are available before assuming that a UIT that has been presented to them is the best choice.

We have not painted the brightest of pictures when it comes to Unit Investment Trusts – honestly we are struggling to find any positives that truly stand out from other investments. If an investor wants to lock in their investment with no management or options for several years and pay a high fee then a UIT is certainly something they should consider. If you like the sounds of that we also could possibly help you find a computer that will last you a couple of years! If you have any questions or comments we encourage you to contact us via the form below.