What Is a Unit Trust

Unit trust definitionThe purpose of creating a unit trust is to make a profit on the assets combined into a fund and distribute the profit received between investors (shareholders) proportionally to the number of shares. An investment unit is a registered security document confirming the right of its owner to a part of the fund property and the redemption of the unit according to the fund rules.

Thus, investment units certify the investor’s share in the fund’s property and their right to receive money from the unit investment fund corresponding to this share. Each investment share gives its owner the same amount of rights. The register of these rights is maintained by an independent organization.

Unit Trust Definition

A unit trust, also known in the UK as a mutual fund, is a property complex without the formation of a legal entity. It is based on trust management of the fund property by a specialized management company in order to increase the value of the fund property. Thus, such a fund is formed from the money of investors (shareholders), each of which owns a certain number of shares.

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A unit trust provides the following benefits to investors:

  • Diversification of investment risks even for minimal investments.
  • Tight control over activities by the state.
  • Transparent infrastructure: the funds of shareholders are separated from the funds of the management company and are stored in a specialized depository.
  • Absence of taxation of the current operations of the fund (including the absence of income tax). Income tax is paid only by the investor and only when the share is sold.
  • Professional management.
  • High liquidity of the unit (for open funds).

Disadvantages of unit trusts are as follows:

  • Higher risk compared to fixed income instruments and legally guaranteed return of funds, such as deposits and high rated bonds. However, there are unit trusts investing only in high rated bonds and bank deposits (money market funds), which, due to diversification, can serve as a tool to further reduction of risks.
  • Additional costs for registration and storage of investment certificates.
  • Constant remuneration to the management company, even at times when the fund suffers losses.
  •        Often, for open-end unit trusts, legislation imposes restrictions on what stocks and bonds a fund manager can buy. A private investor does not have such restrictions.

To reimburse costs associated with the issuance and redemption of investment shares, management companies often introduce discounts and allowances.

Unit Investment Trust

The main characteristic of a unit investment trust is the direction of investment. It is possible to choose stocks, bonds, currency, real estate or art objects. Many trusts combine several types of assets at once. Accordingly, there are the following types of unit investment trusts:

  • Bond unit trusts invest in debt securities with a known yield to maturity (bonds) issued by the UK or global companies. Bond trusts can be compared with bank deposits in their reliability - they have low investment risk, and the target yield, as a rule, is higher than deposit rates. For beginners, this is the most suitable option, allowing them to increase funds and avoid disappointment in investments.
  • Stock unit trusts are the most aggressive investment option in terms of risk and profitability. Therefore, they are recommended for investors who are tolerant to a high level of risk. These funds can provide the highest profitability, but at the same time there is a risk that the stock prices can rise or fall significantly. These unit trusts can invest either in stocks of companies from several economy sectors or in stocks of companies from one sector, for example, energy. This allows you to earn on the growth of individual industries, but with a high level of risk.
  • Mixed unit trusts consist of stocks and bonds. They are focused on higher target returns than bond trusts, but are less exposed to investment risk than stock trusts.
  • Real estate unit trusts are a convenient tool for investing in commercial and residential real estate. A private investor does not need to buy a shopping center or a large warehouse alone in order to receive income from renting it out. It is enough to invest money in a unit trust, which will buy a property for all of its shareholders. Real estate investment trusts are typically closed, because the fund collects money only during a certain period of time. When the necessary amount has been collected, the reception of funds ceases (is closed), the fund buys real estate and becomes its owner. After a specified period of time - 3 to 5 years - the fund sells real estate, allowing the investors to earn on a possible increase in its value. Such funds can also pay the shareholders the income received from the rental of real estate.
  • Index unit trusts include securities of exchange-traded funds (ETFs) consisting of a set of securities that completely duplicate the structure of the corresponding ETFs, such as S&P 500 or EURO STOXX 50. They are preferred for long term investment strategies.

Unit Trusts UK

In addition to unit trusts, the United Kingdom also features the so-called open-ended investment companies (OEICs). They work in the same way as unit trusts, but are organized as corporations and not as trusts. The OEICs have existed in the UK since 1996 and are subject to the Open-Ended Investment Company Regulations. Today, the OEICs are a more common legal form of open-ended investments in the UK than the unit trusts.

Summary

So what is a unit trust? It is a collective financial instrument with which the funds of many investors are combined into a single fund specially created for this purpose. The fund is created by a specialized, state-controlled management company, which has the necessary license. Unit trusts give investors a range of benefits, such as portfolio diversification, state control, high liquidity, etc. At the same time, they have drawbacks, such as higher risks and extra costs.

Now you know the unit trust definition. For more definitions, visit our financial dictionary at https://www.monfex.com/financial-dictionary

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