Municipal Investment Trust: What It Is, How It Works

What Is a Municipal Investment Trust?

Municipal investment trusts are a type of unit investment trust (UIT) that invests solely in municipal securities. Municipal investment trusts are designed for higher-income investors seeking tax-free income.

How a Municipal Investment Trust Works

A UIT is an investment company that offers a fixed portfolio, generally of stocks and bonds, as redeemable units to investors for a specific period of time. Specifically, municipal investment trusts allow individuals to invest in a diversified pool of municipal bonds—also called munis—which passes through tax-free income. UITs, just like mutual funds and closed-end funds, are defined as investment companies.

Municipal investment trusts allow individuals to invest in a diversified portfolio of muni bonds with a low initial investment requirement. As with all UITs, municipal investment trusts are sold by investment advisors and an owner can redeem the units to the fund or trust, rather than placing a trade in the secondary market. Investors can redeem municipal investment trust shares, or units, at net asset value (NAV) to the trust either directly or with the help of an investment advisor.

Mutual Funds vs. Unit Investment Trusts

UITS are similar to mutual funds in that they both consist of collective investments in which many investors combine their funds to be managed by a portfolio manager.

UITs are bought and sold directly from the company that issues them, although sometimes they can be bought on the secondary market. This makes them similar to open-ended mutual funds. UITs are also issued via an initial public offering (IPO), which makes them like closed-end mutual funds.

An important difference between UITs and mutual funds is that UITs aren't actively-traded. Securities in a UIT aren't bought or sold unless there's a change in the underlying investment, such as a corporate merger or bankruptcy. Investments in a mutual investment trust are held until maturity, and some even have a maturity date.

Typically, the management fees of a municipal investment trust are lower than the management fees of a mutual fund, partly because there is not as much active management involved.

Mutual investment trusts are available through brokers and usually have a sales charge and a minimum investment requirement. However, municipal investment trusts do not charge a commission to execute a sell order.

Advantages and Disadvantages of a Municipal Investment Trust

There’s a lot to like about municipal investment trusts, in that they can offer muni-bond diversification at a fairly low price. One of the primary advantages that this type of trust offers is a monthly payout of income, as opposed to the quarterly or semiannual payment of interest common with most individual municipal issues. Also, some investors prefer to do their homework about individual bond holdings ahead of time, and like that the holdings in a municipal investment trust will not change.

In comparison, the inability to buy or sell prior to maturity limits some investment strategies that municipal investment trusts employ. A mutual bond fund likely costs more. Yet many muni bond funds employ tactical techniques to take advantage of shorter-term market conditions. For example, some municipal bond funds will sell bonds just prior to maturity if there is a profit incentive to do so.

They also can quickly move to new opportunities. Say bonds of municipal hospitals recently took a hit because of proposed legislation, but the manager thinks the market has significantly overreacted. A mutual fund bond manager can take advantage of that situation, where managers of a municipal investment trust may not be able to do the same.