Cater Wealth Management
Tax Free* UIT Strategy
What is a UIT?
Unit Investment Trusts (UITs) are a fixed portfolio of stocks, bonds or other securities. These types of portfolios offer full transparency as of the date of deposit, as well as the mandatory termination date of the trust. While it is not common, a trust may terminate early as described in the prospectus. UITs offer an attractive opportunity for investors to own a portfolio of professionally selected securities tailored to their specific needs and objectives. As a point of contrast, while many actively managed funds continually buy and sell securities, thereby changing their investment mix, the securities held in a UIT generally remain fixed. UITs enable you to gain targeted investment exposure to an asset class, investment style, or market sector in a single transaction. UITs can be redeemed at the end of the day for the fair market value of the investment, making UITs very liquid.
How do we use UITs to provide tax-free* income?1
We use UITs containing closed-end municipal bond funds to implement the majority of our tax-free strategies. The UITs we invest in terminate in 2 years with the option to roll funds into the next series. We invest in these, not as if they were 2 year investments, but as if they were forever investments (as long as the client’s investment objectives and liquidity needs don’t change). This strategy offers diversification and rebalancing without being overly managed. *Income is federally tax free. State and local taxes may apply.
What does it cost?1
Total sales charges are 2.75% over a two year period. Our compensation is a flat 2% (1% per year). The UIT sponsor and our broker dealer, First Allied Securities, splits .75%.
Our benefits include professional selection of the portfolio, legal and accounting fees, preparation and distribution of the prospectus and other documents, monitoring of the portfolio, proper reporting and distribution of all cash flows (income and principal) and tax reporting. All of the UIT sponsors on our platform charge the same fees, we have no incentive to use one over the other except performance.
Our Strategy2
Professional selection of the portfolio, rebalancing, and diversification are the key advantages of our strategy. One UIT may hold as many as 35 municipal Closed-End Funds. A typical municipal Closed-End Fund may hold hundreds of individual bonds. We make one investment and own an undivided interested in thousands of professionally managed and monitored municipal bonds.
There are hundreds of Closed-End Funds in the municipal bond category. They are all different. Some are investment grade, some all high yield (junk). Some are state specific, some are national. Some long term, some short duration.
Our preferred sponsors have dedicated professionals and proprietary data and analytics to help them choose which funds to include in their UITs.
Why not just buy individual municipal bonds funds?2
It is true, there are individual municipal bond funds that performed better than UITs did last year. There are also funds that performed much worse. Our experts choose what they consider to be the best funds today. They look at credit quality, duration, diversification, market price vs. net asset value, quality and stability of management, current yield and a host of other variables. They also responsibly utilize leverage (debt) to enhance current yield. The best funds today will most likely not be the best 2 years from now. Things can and do change. (Puerto Rico?)
Closed-End Funds vs Open End or Traditional Mutual Funds
The main difference between Closed-End Fund and traditional mutual fund structures is that traditional mutual funds are open-ended, meaning they are continually redeeming and selling new shares. while Closed-End Funds are just that, closed.
From the fund manager’s perspective, Closed-End Funds have a distinct advantage that they can pass along to the investor. A good investment manager seeks to buy when prices are low, and sell when prices are high.The way mutual funds operate often forces managers to buy when prices are high, and sell when prices are low. In order to understand why, we have to take a look at how the funds operate.
Mutual funds can be purchased and redeemed at the end of each day, meaning that managers must deal with the ebb and flow of liquidity in their funds. When a category is popular, prices go up and cash flows in. Managers are forced to buy, even if they think prices are too high. Conversely, if prices are falling investors are prone to asking for their money back. Managers are forced to sell to meet redemptions, often when they would rather be buying to take advantage of lower prices.
Closed-End Funds on the other hand, allow the manager to focus on managing the funds without worrying about the constant flow of liquidity. No new shares are issued after a Fund is established. More importantly, shares are not redeemed. If an investor wants his money back he simply sells, usually on the New York Stock Exchange, to another investor. A Closed-End manager has one objective, performance, whereas an open end fund manager has the dual objective of performance and sales of new shares. Because of this, the advertising and marketing fees (12b1) typically found in traditional open end funds are not found in Closed-End Funds.
A distinct disadvantage of Closed-End Funds is the inability to liquidate at Net Asset Value (NAV). Closed-End Funds tend to trade at a discount to NAV. Traditional mutual funds can always be liquidated at their NAV.
Closed-End Funds are not a new or flashy investment. The first mutual fund ever created was closed end, and there are funds existing today that have been around for over 100 years. The reason you may not have heard of them is that with new high commission alternatives, brokers have few reasons to recommend them.
Risk Considerations
- Security prices will fluctuate. The value of your investment may fall over time.
- The trust invests in shares of closed-end funds. Shares of these funds tend to trade at a discount from their net asset value and are subject to risks related to factors such as the manager’s ability to achieve a fund’s objective, market conditions affecting a fund’s investments. The trust and funds have management and operating expenses. You will bear not only your share of the trust’s expenses, but also the expenses of the funds. By investing in other funds, the trust incurs greater expenses than you would incur if you invested directly in the funds.
- The funds held by the trust invest in municipal bonds. Municipal bonds are debt obligations issued by state and local governments or by their political subdivisions or authorities. States, local governments and municipalities issue municipal bonds to raise money for various public purposes such as building public facilities, refinancing outstanding obligations and financing general operating expenses. These bonds include general obligation bonds, which are backed by the full faith and credit of the issuer and may be repaid from any revenue source, and revenue bonds, which may be repaid only from the revenue of a specific facility or source.
- The municipal bonds held by the funds may be fixed-rate obligations that will decline in value with increases in interest rates, an issuer’s worsening financial condition or a drop in bond ratings. The longer the maturity of a security, the greater the risk of a decline in value with increases in interest rates. The effective maturity of longer term securities may be dramatically different than shorter term obligations. Investors may receive early returns of principal when securities are called or sold before they mature. Investors may not be able to reinvest the proceeds they receive at as high a yield. The default of an issuer in making its payment obligations could result in the loss of interest income and/or principal to investors.
- A portion of distributions from the trust may be subject to the alternative minimum tax. While distributions of interest from the trust are generally exempt from federal income taxes, a portion of such interest may be taken into account in computing the alternative minimum tax.
- The trust is not actively managed. Except in limited circumstances, the trust will hold, and continue to buy, shares of the same securities even if their market value declines.
- The sponsor may offer successive Trusts with similar portfolios thereby allowing the investor to pursue the same strategy over a number of years. Investors should consider their ability to pursue investing in successive Trusts, if available. There may be tax consequences associated with investing in the Trust and rolling over an investment from one Trust to the next.
- A diversified portfolio does not assure a profit or protect against loss in a declining market.
There are fees and expenses associated with investing in closed end, UITs and mutual funds, including portfolio management fees and expenses and sales charges. These investments are sold only by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about these investment companies, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Works Cited
