As the U.S. stock market nears a decade of expansion and enters a potential "new normal" of increased volatility, independent financial advisers are finding it harder to rely on a standard buy-and-hold strategy.
In this landscape, unit investment trusts, or UITs, are positioned to play a greater role for advisers. Despite
recent reports of the UIT structure
being abused by certain bad actors in the wealth management landscape, the fact is that UITs can benefit clients significantly when implemented correctly.
As a fixed set of securities that are held for a specific period, a UIT by its very nature is a more targeted and weighted approach than mutual funds or exchange-traded funds. UITs, at their best, target specific segments of the market that a manager finds attractive while maintaining the liquidity of more traditional funds but without the exposure to style-drift risks or performance contamination.
Because the holdings in a UIT are transparent, this allows a financial adviser to take greater control of overall exposure to specific companies or industry sectors and avoid taking concentrated or overlapping positions that might cause portfolios to suffer unnecessary losses.
UIT structure
First, some basics: Most unit investment trusts issue redeemable securities that the UIT may purchase back at the request of the investor, with the price based on the daily net asset value, or NAV.
UITs normally conduct a public offering of a fixed number of units, then facilitate a secondary market that allows investors to buy and sell units.
When established, many UITs set a termination date that ends the investment vehicle and pays investors the remaining proceeds from securities held at the time. The lifespan of an equities-driven UIT often ranges from a little over one year to two years. UITs consisting of bonds, however, may last through the maturity date of the underlying holdings.
During their lifespan, UITs have the ability to pay dividends or interest to investors off the holdings.
The best UITs reevaluate the weightings of the various underlying holdings and may change them with every new issue, typically quarterly, based on their market performance. UITs are supervised by portfolio experts but typically forgo the fees associated with active investment managers.
UITs and ‘choke point' investing
Put simply, UITs allow for the highest amount of specific return for a specific behavior because they home in on the theme, or even a particular slice of the theme, tied to that behavior.
One investment philosophy that advisers could adopt sees UITs as allowing clients to capture the greatest opportunities of value creation available to equity investing.
This occurs by identifying the "big knowable themes" driving human behavior and consumption trends, then aligning these themes with key "choke points" in the supply chains that feed these trends. Big knowable themes can be viewed as activities, technologies and policies giving rise to tailwinds or headwinds that affect economies, earnings and portfolios.
Choke points, meanwhile, are best thought of as value-chain advantages occurring for a few companies that have pricing power, either within an industry or over a product that satisfies a significant customer need.
Real-world example
Perhaps the best real-world example of how to apply this investment philosophy is the phenomenon of e-commerce.
Let's say you're on a social media hub where you see a video selling a piece of clothing. You might use a search engine to find reviews or product discounts. Once you're ready to purchase, it's on to a retail payment portal to enter your credit card information. Then you likely get the package shipped to your home via a delivery company.
Throughout this process, your internet connection was supplied by a partnership between the local telecom company and a provider of wireless tower infrastructure.
About two dozen well-known companies exploit their respective choke points and extract healthy profits while maintaining that digital e-commerce ecosystem. Advisers, in turn, can enhance client portfolios by using UITs designed to reap gains from that ecosystem.
Big knowable themes and choke points also can be applied to UITs specializing in civil infrastructure and media content, as well as any number of other strategies and sectors.
Successful financial advisers of the future will be unafraid of moving beyond old ways of investing that fail to give clients the greatest opportunities to capture growth.
Indeed, advisers with real conviction in their investment philosophy may discover that UITs present particularly innovative ways to pursue positive returns.
(More: Finra's Focus on UITs)
Dryden Pence is the chief investment officer of Pence Capital Management (www.pencecapital.com), a Newport Beach, Calif.-based third-party asset manager.
