Unit investment trusts, hybrid investment products which fall somewhere between mutual funds and direct ownership of either equity or fixed-income securities, could gain in popularity and pose a growing threat to mutual fund assets, some industry executives say.
For the first 11 months of 1998 ending November 30 (the latest figures available) mutual funds as a whole took in more than $481 billion, according to the Investment Company Institute. UITs took in $57 billion during the same time period. While that is only a fraction of the inflows to mutual funds, it represents a 54% increase in flows from 1997 when UITs attracted close to $37 billion. By comparison, inflows to mutual funds grew 36 percent in the comparable periods. In the first 11 months of 1997, mutual fund inflows were $354 billion.
UITs, also known as defined or focused portfolios, buy and hold a pre-determined basket of equity and/or fixed-income securities for a defined period of time. Sponsors pre-set those terms. Equity UITs may carry one-, two- or multi-year terms while fixed-income UITs may have terms of 15-years or longer. Unitholders have the option to roll over assets into a new, succeeding UIT which reshuffles the portfolio when the term expires, or redeem their units.
Unlike mutual funds, UIT portfolio securities are not regularly bought and sold. In fact, restrictions prevent portfolio selections from being changed except under extraordinary circumstances, said Mark Kneedy, managing partner with the law firm of Chapman & Cutler in Chicago. These circumstances include a change in the credit-worthiness of a stock or if redemptions must be met. But like mutual funds, UITs must price the portfolio each day and offer unit-holders daily liquidity. In some cases, unit-holders may be paid "in kind" with a transfer of securities which protects the portfolio and allows the investor to defer a taxable event.
Unlike fund investors who may continuously purchase shares at a current share price, UIT investors purchase units at predetermined prices.
Most UIT's are sold through broker/dealers and any up-front or deferred sales charges are deducted during the UITs initial subscription period. Up front sales charges can run two percent to four percent on average. There are no management or 12b-1 fees. But most UITs charge ongoing "supervision" fees for tracking individual securities and trustee fees which cover some administrative expenses. Like index mutual funds, UITs are passively managed and consequently tax efficient.
Fixed-income UITs have been offered by sponsoring firms such as John Nuveen & Co., Merrill Lynch and Smith Barney for the past 35-plus years, but they have not been promoted heavily. The current rush of assets into UITs is occurring because of the proliferation of equity UITs, spurred by investors' growing appetites for equity products, said industry executives. Ten years ago, some 90 percent of UITs were fixed-income products. Today, the numbers are reversed with more than 90 percent of new UITs being equity-based.
The surge in equity UITs began in the early 90s with the introduction of the "Dogs of the Dow" UIT sold by a syndicate of wirehouses. Many companies have since copied the trust's strategy which is to invest in the ten highest yielding securities of the Dow Jones Industrial Average. In October, 1997, Charles Schwab launched its version called The Schwab Ten Trust. This past May, John Nuveen & Co. in Chicago launched its own version, the "Dow 10" as well as a, "Dow 5" UIT.
UIT offerings have expanded to include many varieties. Van Kampen introduced an Internet trust in 1996 which invests in Internet stocks. It now has $620 million in assets. Merrill Lynch is currently offering a technology sector UIT which invests in 100 top technology stocks. Nuveen just launched a UIT which invests in online businesses and a new energy portfolio is being planned.
Unique UITs that employ special or proprietary strategies are especially popular. Nike Securities of Lisle, Ill. offers The O'Shaughnessy Reasonable Runaways Growth Trust which applies a growth and value investment strategy developed by O'Shaughnessy Capital Management. Private label UIT offerings are also popular, said Phil Lebeau, a Van Kampen spokesperson. Van Kampen recently launched the fourth generation Peroni Top Ten Growth Trust which includes the top ten stock picks of Eugene Peroni, director of technical research for Janney Montgomery Scott, a brokerage firm in Philadelphia. The trust is sold exclusively through Janney brokers.
UIT's are popular among commissioned salespeople because they welcome having index products to sell, said Avi Nachmany of Strategic Insight in New York. Most index funds are no-load. Dan Waldron, vice president, director of UIT product management at Van Kampen in Chicago which has $11 billion in UIT assets, says his firm is currently selling more UITs than index funds.
The UIT structure also allows investors to know exactly what stocks and bonds they own, said David Partain, vice president of Nike Securities. Many mutual fund investors lose track of what their fund is invested in because of frequent portfolio turnover.
UIT's are also appealing to both investors and brokers because of the simplicity of the product, said one UIT sponsor. With UITs, brokers do not have to track dozens of individual securities for a client.
But not all advisers are enthusiastic about UITs. Some have decided to take sides and offer either funds or UITs. And advisers are concerned that the success of UITs may begin to cannibalize assets flowing into funds. Since advisers do not get advisory fees for UITs, they would prefer to see assets going into mutual funds.
Last month, Delaware Group sold its UIT business to Nike Securities which now has a combined $50 billion of UIT assets. Delaware, which inherited the UITs by way of its purchase of Voyageur Asset Management in 1997, decided to focus on its core mutual fund business and chose to deploy assets elsewhere rather than spend on building up the UIT infrastructure, said a Delaware spokesperson.
Fidelity, which launched a handful of fixed-income UITs in 1996, now has a stable of 20 UITs. But the Boston firm scrapped plans to launch equity UITs when its mutual fund arm balked at the creation of a competing product, according to a source close to Fidelity.
A Fidelity spokesperson declined to confirm that the plans had been scrapped. The spokesperson, Jessica Johnson, said only that the company does not plan to expand its UIT business.
Other advisers offer both products, believing the two products can coexist. Both Nuveen and Van Kampen, for example, offer both products as part of complementary portfolio programs. According to Waldron of Van Kampen, not only has there been no cannibalization of fund assets, but fund managers actively help choose the UIT securities.
"Equity UITs are a tremendous way to capture long-term strategies while mutual funds capture the dynamic strategies of short-term trades," said Bob Burke of Nuveen.