An introduction for investment industry professional

1. Unit Investment Trusts
An Introduction for Investment Industry Professionals
September 2013
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2. Agenda
Definition
Distribution
Comparison
UITs in Portfolios
Risks
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3. Definition
What is a UIT?
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4. What is a UIT?
• UIT stands for Unit Investment Trust
• A UIT is a type of commingled investment vehicle
available to U.S. investors
• The Investment Company Act of 1940 establishes the
definition of UIT
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5. 1940 Act Definition of UIT
Section 4 (2) of the 1940 Act says:
‘‘Unit investment trust’’ means an investment company which
(A) is organized under a trust indenture, contract of custodianship
or agency, or similar instrument,
(B) does not have a board of directors, and
(C) issues only redeemable securities, each of which represents an
undivided interest in a unit of specified securities;
but does not include a voting trust”
[Emphasis added.] Link to text: 15 USC 80a–4: Classification of investment companies
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6. “Unit of Specified Securities”
• This term is not defined in the 1940 Act
– It is commonly referred to as a requirement for a fixed or
unmanaged portfolio
• The SEC has said that the investor in a UIT must know
with a “high degree of specificity” the securities that
will be in the UIT portfolio
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7. Practical Definition of UIT: 5 Components
Investment vehicle that holds a “fixed”
portfolio of investments for a defined life and
offers redeemable units to investors
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#1 #2
#3 #4
#5

8. Component #1: Investment Vehicle
• Today, UITs are almost always organized as common
law trusts
– UITs are not incorporated entities, like the statutory or
business trusts used for open-end funds
– UITs are created by parties entering into a contract in the
form of a trust agreement or indenture
– UITs do not have a board of directors or board of trustees
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9. Component #1: Investment Vehicle (cont.)
• For tax structure, a UIT can be either a registered
investment company (RIC) or grantor trust
– RIC has the same tax structure as most open-end mutual
funds and has diversification, income and distribution
requirements, but may “vary the investment” of
unitholders
• I.e., under tax rules, the fund can be actively-managed
– Grantor trust has no diversification, income or distribution
requirements, but cannot vary the investment of
unitholders (26 CFR 3701.7701-4)
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10. Parties Involved in a UIT
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Depositor
or Sponsor
Trustee
Evaluator Supervisor

11. Role of the Depositor or Sponsor
• A Depositor or Sponsor is required to create a UIT
– “Orphan trusts” lose their Sponsor after creation, though
these orphan trusts are rare
• In modern UITs, the Depositor creates the UIT by:
– Depositing securities into the trust
– Receiving units of the trust in exchange
– Selling those units to the public (taking role of Principal
Underwriter)
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12. Role of the Depositor or Sponsor (cont.)
• Depositors are normally broker-dealers
– In order to comply with regulations on conducting
securities transactions to form the UIT and on sale of units
to the public
• The Depositor normally:
– Lends its brand name to the UIT
– Is responsible for code of ethics and compliance policies
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13. Role of the Trustee
The Trustee:
• Is required to create a UIT
• Acts as custodian by holding securities in trust
• Provides fund administration services
– Includes daily striking of NAV
• Normally acts upon instructions from the Depositor
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14. Role of the Evaluator
• An Evaluator is not required, but often present
– The role may be handled by the Trustee
• The Evaluator values securities daily for NAV
calculation
• The Evaluator:
– Is generally a registered investment adviser
– Can be the Depositor (or affiliate) or an independent 3rd
party
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15. Role of the Supervisor
• A Supervisor is:
– Not required, but often present
– Generally a registered investment adviser
• The Supervisor:
– Monitors securities in portfolio (“surveillance”)
– Advises depositor on actions that might be needed
• The Supervisor’s role is more limited than that of an
investment adviser to an open-end fund
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16. Component #2: “Fixed” Portfolio
• A UIT portfolio is selected at creation or inception:
– By the Depositor/Sponsor or another investment manager
or
– By applying a quantitative screening strategy
• For example, a popular UIT securities selection strategy is “Dogs of
the Dow,” which involves selecting the 10 highest dividend yielding
stocks from the Dow Jones Industrial Average
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17. Component #2: “Fixed” Portfolio (cont.)
• A UIT does not have a portfolio manager actively
buying and selling portfolio securities during the life
of the UIT
– Therefore, a UIT does not have an investment adviser
– A UIT’s holdings may change due to bond
calls, mergers, etc.
– The Supervisor makes recommendations on corporate
actions, proxy votes, etc.
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18. Trading in the “Fixed” Portfolio
• The “specified securities” may be index components
– Trading is allowed to keep the portfolio in line with index
– ETFs may be structured as UITs (for example, the SPDR S&P
500 is a UIT)
• The Depositor can instruct sale of securities to:
– Pay expenses
– Meet unitholder (investor) redemption requests
– In very limited circumstances, to protect the UIT (for
example, when there are serious credit concerns regarding
issuer)
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19. Component #3: Investments
• Traditional investments were historically municipal
bonds
• Today there are UITs available for most investments:
– Stocks: common and preferred, U.S. and foreign
– Bonds, all types
– Open-end mutual funds, ETFs, closed-end funds*
– Derivatives
– Commodities
*UITs are among the largest holders of closed-end fund shares
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20. Component #4: Defined Life
Defined life has 2 forms:
• “Equity style UIT”*
– Has stated Mandatory Termination Date in prospectus
– Typically has a life of 15-24 months
• “Fixed-income style UIT”
– Terminates when last bond matures, is called, or is otherwise
liquidated from portfolio
– Is normally available in most maturity ranges
*A UIT owning bonds can be set up in the “equity style,” although that is very
rare.
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21. Component #5: Redeemable Units
• UIT units are “redeemable securities” under the
Investment Company Act of 1940
• As with open-end mutual fund shares:
– Investors can redeem UIT units at the end of every
business day
– Redemptions are made based on the NAV calculated at
that time
– Orders received after market close receive the price next
determined (generally the following business day)
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22. Distribution
Sales of UITs to the Public
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23. Distribution of UIT Units
• Distribution of units is the responsibility of the
Principal Underwriter, who is almost always the
Depositor or Sponsor
– Distribution is generally continuous for limited period
– Some fixed-income UITs will use an underwriting syndicate
in an IPO process, similar to the distribution of closed-end
funds
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24. Distribution of UIT Units (cont.)
• UITs are generally sold through intermediaries
(broker-dealers or RIAs)
– Investors typically do not buy units directly from the
Depositor/Sponsor (unless the Sponsor is a retail broker-
dealer)
– Sales charges, discounts (breakpoints, fee-based
account, rollover) are articulated in the prospectus
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25. UIT Sales Charges and Expenses
• The investor in a UIT pays a sales charge
– The sales charge compensates the Depositor (for
assembling and marketing the UIT) and intermediaries
who helped distribute unites
– Some portion of the sales charge may be deferred and
paid during the first part of the life of the UIT
– The sales charge is usually reduced for an investor rolling
proceeds from a terminated UIT into new UIT
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26. UIT Sales Charges and Expenses (cont.)
• Ongoing operating fees and expenses are generally
low compared to managed, open-end funds
– A UIT does not charge a management fee, since it is not
actively managed
– A UIT does not have expenses related to board of directors
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27. Life of a Sample Equity UIT
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28. Life of a Sample Fixed-Income UIT
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6
(Fixed number of units issued at inception only;
offering period lasts until all units sold) 20% of Principal Amount of Bonds Mature Each Year

29. Comparison
UITs vs. Other Fund Types
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30. Fund Type Comparison: Structure
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31. Fund Type Comparison: Features
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32. Fund Type Comparison: Features (cont.)
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33. UITs in Portfolios
Pros and Cons
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34. Why UITs?
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Defined
• Known portfolio
• Known start and
end dates
• Specified
investment process
• More predictable
income stream from
fixed portfolio
Complementary
• Add passive
component to
portfolio
• Diversify by asset
class, sector, etc.
• Target maturity to
match specific goal
Access
• Broad variety of
offerings
• Specific income
profiles

35. Advantages from Investor Perspective
• The simplicity and low launch cost of UITs to the Sponsor
means that UITs can:
– Be fast to market to capture investment opportunities, even short-
term ones
– Can invest in very focused segments of market
• Because UITs have no active management, there’s no style
drift
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36. Advantages from Investor Perspective (cont.)
• UITS have a more defined income stream given their stable
portfolio
– The defined income stream can be particularly attractive to fixed
income investors
• UITs have low ongoing operating costs compared to other
vehicles
• The fixed termination date of UITs encourages investors to
review portfolio and investment positioning
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37. Disadvantages from Investor Perspective
• Sales charges may offset operating cost advantage
• There is less information available on UITs vs. many open-end
funds and ETFs (no Morningstar reports, etc.)
• The lack of active management means UIT portfolios will not
respond to market/economic changes
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38. From Industry Perspective
• Difficult fit for 401(k)s given limited offering periods
• Limited industry data available (sales, assets, etc.)
• Low level of visibility vs. other investment vehicles
• Less investor analytics, demographic information available
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39. Risks
What You Need to Know
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40. Risks
As with all investments, investors can lose money
investing in UITs. UITS might not perform as well as an
investor expects for a number of reasons.
• Security prices will fluctuate. The value of any
investment, including the value of a UIT, may decline.
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41. Risks (cont.)
UITs will be affected by the performance of their investments. Risks to
consider include:
• A security issuer may be unwilling or unable to declare dividends, may reduce the level of
dividends declared, and may be unwilling or unable to make interest and/or principal
payments when due. This may result in a reduction in the value of an investor’s units.
• The financial condition of an issuer may worsen or its credit ratings may drop, resulting in a
reduction in the value of units. This may occur at any point in time, including during the initial
offering period of a UIT.
• UIT portfolios are not actively managed. Except in limited circumstances, UITs will hold, and
continue to buy, shares of the same securities even if their market value declines.
• UITs may invest in securities issued by foreign companies which present risks beyond those of
U.S. issuers. These risks may include market and political factors related to the company’s
foreign market, international trade conditions, less regulation, smaller or less liquid
markets, increased volatility, differing accounting practices and changes in the value of
foreign currencies.
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42. Risks (cont.)
• UITs may invest in securities issued by smaller companies which are often more volatile and
may have lower trading volumes than securities of larger companies. Small companies may
have limited products or financial resources, management inexperience and less publicly
available information.
• UITs may be concentrated in securities issued by issuers in a single industry sector, located in
a single geographical region or of a particular type. Negative developments impacting these
industry sectors, regions, or issuer type will affect the value of an investment in such a UIT
more than would be the case in a more diversified investment.
UITs may be subject to additional risk depending on the investment strategy
and/or types of securities held by the trust. The prospectus of the UIT for a
particular trust should be consulted for more information associated with the
risks of an investment.
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43. Summary
The Investment Company Act of 1940 defines UITs
UITs are sold through intermediaries
UITs have unique features vs. other fund types
UITs have pros and cons for investors
UITs have risks you should understand
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44. Acknowledgments
This presentation is based on a NICSA webinar presented on December
12, 2012, and developed by:
Scott Anderson
Partner
Chapman and Cutler, LLP
Jack Tierney
Director of Unit Trust Product Research, Development and Management
Invesco
NICSA members can access an archive of the webinar by clicking here.
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45. Keep Up on the Trends Through NICSA
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