Unit trusts are investment products that are often grouped together with exchange-traded funds and mutual funds. However, there are important differences between these asset classes, and some of those differences highlight disadvantages of unit trusts that investors need to know.
No Changes in Holdings
One of the most obvious differences between, say. an actively managed mutual fund and a unit trust could be one of the biggest disadvantages of the latter. Once a unit trust is formed, its underlying holdings remain the same through the termination date. That's an advantage if those holdings perform well, but if they drop in value the trust investor is left holding a bag full of laggards and will lose money. Actively managed funds can trade in and out of various holdings. Unit trusts can't, and that exposes investors to potential risk.
Investors need to remember that although they are not paying for active management with unit trusts, fees associated with these products are comparable to mutual fund loads. The disadvantage here is that these fees are often far higher than what an investor will find with a passively managed index fund or an exchange-traded fund. The higher the fees, the bigger their bite out of the investor's returns over time.
On the surface, the money flowing into a unit trust would not appear to be a disadvantage for current investors in the trust. After all, new inflows to exchange-traded funds or mutual funds don't put current investors at any noticeable disadvantages. Again, things are different with unit trusts. Inflows to the trust can dilute existing investors’ slices of the pie. And the bigger the trust gets, the more limited the manager’s investment opportunities become.
Only One Way to Buy
With individual stocks and exchange-traded funds, investors have myriad ways to purchase these securities. The investor can buy them through dozens of brokerage firms; it's only a matter of how much the investor is willing to pay in commissions. Unit trusts do not offer that level of convenience. These investments must be purchased directly from the trust issuer. Purchase pricing is not competitive, and that's another disadvantage for investors.
Todd Shriber is a financial writer who started covering financial markets in 2000. He worked for three years with Bloomberg News and specializes in analysis of stocks, sectors and exchange-traded funds. Shriber has a Bachelor of Science in broadcast journalism from Texas Christian University.