The unit investment trust has quietly blossomed into the dominant investing vehicle for Build America Bonds — the taxable municipal debt created under last year’s stimulus legislation.
Four companies — chief among them Invesco Van Kampen — have launched more than 110 BAB UITs with roughly $3.3 billion in total assets.
Without getting much press, BAB UITs are now considerably bigger than BAB-devoted mutual funds, closed-end funds, and exchange-traded funds combined.
Market participants say UITs are suitable for the type of investing people use BABs for: passive, long-duration exposure.
“Investors are looking for an investment vehicle that can provide consistent income,” said Craig Falduto, head of unit investment trust research at Van Kampen. “It’s a very consistent income stream.”
The typical UIT fee structure involves a fairly heavy upfront payment followed by low annual costs until liquidation. Because BAB trusts tend to be long term, an investor enjoys lower overall costs with the UIT structure than with something like mutual or closed-end funds, which entail higher annual expenses.
“Usually, the longer the trust the better the argument gets with the UIT,” said Richard Stewart, senior vice president of unit investment trusts at Advisors Asset Management — the first company to launch a BAB UIT. “It gives you a lower average annual expense. You’re spreading it over more years.”
A UIT is sort of like a passively managed mutual fund that never reinvests principal payments.
A UIT manager populates a trust with municipal bonds and sells ownership in the form of “units” investors can redeem for cash any time, based on their share of the quoted value of the bonds in the trust. The trust pays monthly dividends.
When the bonds in the trust mature, the UIT returns the cash to shareholders instead of reinvesting it. When the last bond in the trust has matured, the UIT is liquidated. A UIT has a defined termination date: whenever its longest-term bond matures.
That makes owning a UIT comparable to owning a diversified basket of idle municipal bonds, as opposed to paying a mutual fund manager to reshuffle holdings and try to beat the market.
“Given that we’re a passive, buy-and-hold structure, that monthly check doesn’t vary,” said Falduto, head of UIT research at Van Kampen.
The UIT is a minor player on the tax-exempt stage. At the end of 2009, UITs held $9.9 billion in tax-exempt debt, according to the Investment Company Institute — about one-third of 1% of the $2.8 trillion municipal bond market.
The Vanguard Limited-Term Tax-Exempt Mutual Fund alone is bigger than the entire tax-exempt UIT space.
The market for BABs is a different story.
The American Recovery and Reinvestment Act in February 2009 authorized municipalities to forsake the customary tax exemption on their debt and instead float taxable bonds featuring a federal subsidy equal to 35% of their interest costs.
The taxable Build America Bonds have introduced municipal debt to new investors and new markets, ones in which the UIT is playing a bigger role.
The BAB UITs’ roughly $3.3 billion in assets represent 2.6% of the $127.86 billion of BABs that have been issued since the inception of the program last year.
BAB UITs’ assets easily eclipse the roughly $1.6 billion in BAB-devoted closed-end funds, $550 million in exchange-traded funds, and $60 million in mutual funds.
Steve Baffico, senior managing director at Claymore Securities, said one of the reasons BAB UITs have proliferated is that they are easier for the sell-side to create.
A manager can launch a UIT in as little as 10 days, Baffico said, whereas a closed-end fund or mutual fund has to go through a filing period that can take months.
“It’s a very low barrier-to-entry way to provide yield, diversification, total return, and institutional price execution in a packaged product,” Baffico said.
The first BAB UIT came to market in May 2010, when Advisors Asset Management launched the $5.8 million Build America Bond Portfolio Series 1.
Coming only a few weeks after state and local governments began selling BABs, the trust bought some of the first to hit the market, including $1.3 million of New Jersey State Turnpike Authority revenue bonds maturing in 2040, which infamously priced at 365 basis points over Treasuries.
AAM has launched 21 BAB UITs with about $200 million in assets.
Next came Van Kampen, with the $34.3 million Build America Bonds Income Trust in July. It has quickly defined itself as the undisputed king of BAB UITs by launching 65 trusts with $2.6 billion in assets.
First Trust joined the market in November, selling the $21.4 million Build America Bonds 1 UIT. The company has introduced 24 BAB UITs with about $500 million in assets.
The latest to join the game is Claymore Securities, which launched its first BAB UIT in July and now has three, with more than $50 million in combined assets.