Of the different types of investment company products available to investors, unit trusts and exchange traded funds -- ETFs -- are at the opposite end of the spectrum. The different types of investment companies -- also including mutual funds and closed-end funds -- are all governed by the rules of the Investment Company Act of 1940. Unit trusts are aimed at the buy-and-hold investor while ETFs allow investors to quickly move in and out of different asset classes.
Unit Trust Features
The unique feature of a unit investment trust -- UIT -- is a set liquidation date. A UIT is formed when a fund sponsor puts together a portfolio of securities to meet certain investment criteria and then sells units in the trust. The units of a new trust are sold to investors in a short period of time and no more units are issued. When the liquidation date arrives, the securities in the trust are all sold and the proceeds distributed to the unit holders. Unit trusts offer the option to reinvest dividends into more units, and most trust sponsors will buy back units at the current net asset value -- NAV -- if an investor wants to cash out before the termination date. Both stock UITs and bond UIT investments are available.
Exchange traded funds are classified as open-end funds and use the same structure as mutual funds. The difference is that ETF shares are not sold directly to individual investors. ETF shares are created in 50,000 share blocks when large financial institutions trade individual securities for the ETF shares. The shares are then traded into the stock exchanges where investors can buy and sell in the same manner as buying and selling individual stocks. An ETF is designed to track a specific stock or bond index or commodity price. The securities held by an ETF are not actively managed, making ETF shares very similar to index mutual fund shares.
Investing in UITs
Unit trust investments are sold primarily through investment brokers and financial advisors. Once the units of a trust have been sold, there is not a secondary market for those units. New investments require the sponsor companies to increase new trust. An investment in a unit trust should be viewed as a long-term investment to be held until the scheduled termination date of the trust. Bond UITs provide a high level of principal value certainty since a trust will be filled with bonds maturing at or near the same date as the trust liquidation date.
Investing in ETFs
The fact that investors can buy and sell ETF shares through a regular brokerage account make ETFs suitable for both short-term trading and as longer term investments. In the short term, ETF share prices move throughout the market day to match changes in the stock indexes and commodities like gold and crude oil. For longer term investors, ETFs provide low-cost exposure to a wide range of asset classes including stocks, bonds, commodities, stock market sectors and international stocks.
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