Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

Exchange Funds Sap Unit Trust Assets

The sharp growth of unit investment trusts in the late 1990s was halted last year, and it may be the emergence of exchange-traded funds that is the biggest reason, according to industry analysts.

Unit investment trusts, also known as defined asset funds, buy and hold a set basket of equities or fixed income securities for a predetermined period of time. They expire when the bonds mature or, in the case of equity unit investment trusts, at a specified date. Investors in unit investment trusts receive an undivided interest in the principal and income of the trust in proportion to how much they invest. John Nuveen & Co. of Chicago and Merrill Lynch and Smith Barney, both of New York, have offered unit investment trusts for over 35 years. Eight companies currently offer them, according to the ICI.

Unit investment trusts traditionally held mostly municipal bonds. However, over the past five years, there has been a movement towards equity unit investment trusts. In 1996, equity unit investment trusts represented about 34 percent of the total unit investment trust market, according to the Investment Company Institute of Washington, D.C. In 1997, that number rose to 49 percent, 60 percent in 1998, and over 68 percent in 1999. The ICI plans to release figures of total assets in unit investment trusts, and their breakdown by investment category for 2000 in the next few months, according to John Collins, a spokesperson for the ICI.

Deposits into unit investment trusts were also on the rise during that time. About $40 billion was deposited into unit investment trusts in 1997, according to the ICI. That number climbed to about $60 billion in 1998. In 1999, industry executives predicted that unit investment trusts would further gain in popularity and threaten mutual fund assets (MFMN 1/25/99). That year, deposits into unit investment trusts peaked at $75.32 billion. However, in 2000, when equity stock funds had record inflows, deposits into unit investment trusts dropped over 14.2 percent to $64.6 billion, according to the ICI.

One reason for the decline is that exchange-traded funds, a similar, yet more flexible product, have become very popular, according to analysts. Unit investment trusts are passively managed and have tax advantages over actively-managed mutual funds, however they do not compete well against exchange-traded funds, according to Scott Cooley, an analyst at Morningstar of Chicago. Unit investment trusts do not have management or 12b-1 fees, however there are up front sales charges of two to four percent, and most charge ongoing supervision' fees for tracking individual securities or trustee fees, which cover administrative costs. Exchange-traded funds do not carry such charges beyond standard broker charges.

"With ETFs, you're actually getting some great flexibility and lower costs than you would have with a UIT," said Cooley. "You'll probably get better tax efficiency as well, depending on how the UIT is structured. For most investors, ETFs are a superior investment product and it makes sense that they'd be growing at a much faster clip."

Earlier this month, ING Funds, a subsidiary of ING Groep of Amesterdam, the Netherlands, sold its unit investment trust business to Investec Ernst & Company of New York. ING had purchased the business in 1999 from Reich and Tang Asset Management of New York. ING is not selling the business because of unsatisfactory results, a spokesperson said.

In April, Merrill Lynch Investment Managers of New York announced that it would discontinue the creation of unit investment trusts in the U.S.

"This move reflects MLIM's continuing effort to strategically evolve our products and services to match the changing needs of our clients," said Jeffrey Peek, president of Merrill Lynch Investment Managers. "We are managing our business by focusing on investment vehicles within MLIM's broad product line that will afford us the greatest opportunity to grow."

Merrill Lynch is the sponsor of the exchange-traded fund-type products, holding company depository receipts, or HOLDRs, and now offers 18 of them, according to the company.