Avoid hype over yield on tax-free unit trusts


November 28, 1993|By JANE BRYANT QUINN | JANE BRYANT QUINN,1993, Washington Post Writers Group

New York -- Ever since the Clinton tax law passed, some stockbrokers have been telephoning tax-shy investors to tout the incredible 7 percent yields on certain tax-free unit trusts. If you get such a call, hang up. You're about to be had.

Even the unit trusts that are sold without hype may not yield the total returns you expect. Because this $99 billion industry is so little scrutinized, you have no idea how well your investment has performed.

Most unit trusts are fixed portfolios of investments -- usually tax-free municipal bonds. A package of bonds is assembled to mature in anywhere from one to 30 years. You buy an interest in that package for a minimum of $1,000.

The bonds are supposed to be held until the trust expires. While you're waiting, you get a pro rata share of the interest or dividends earned. If any of the bonds in the trust are sold, you also get a pro rata share of the principal. The remaining principal is distributed when the trust matures.

You can usually redeem your shares early. But depending on zTC market conditions, you might receive more or less than you paid.

But back to that delicious 7 percent yield. It's known as the "estimated current return," and it tells you the size of your monthly dividends relative to the sum you invested. The return is so high because these particular unit trusts contain high-interest municipal bonds that were issued back in the early 1980s. Because of their high rates, they sell for much more than their face value.

But long-term municipal bonds can usually be redeemed by their issuers after just 10 years. And indeed, that's what's happening today. These bonds are being called in at face value. Your trust then swallows a capital loss, which diminishes your total return.

So what you really need to know from the stockbroker is the unit trust's "estimated long-term return," which adjusts for these losses (among other things). Your actual return on long-term trusts, if you hold to maturity, is more likely to be in the 5 percent range. (Note that even the estimated long-term return slightly overstates your likely yield on a unit trust, because it doesn't fully account for the effect of the up-front sales charge.)

The Securities and Exchange Commission requires stockbrokers and unit-trust sponsors to disclose, in their ads and prospectuses, both the current return and the estimated long-term return. On newly issued unit trusts, those two returns should be pretty close, Michael Kochmann of the Defined Asset Group at Merrill Lynch told my associate, Amy Eskind.

But they can be quite different on older trusts that are being resold. Good stockbrokers give you both returns -- the high one and the low one -- and explain them.

Some stockbrokers, however, "forget" (they aren't required to give both returns if they sell you by phone -- yet another reason to reject cold calls).

The larger question is why buy unit trusts at all when you can buy tax-exempt mutual funds?

Unit trusts claim that they outperform mutual funds, but who knows? Most trusts don't publish daily performance data, so their case is doubtful.

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