In DC plans of all sizes, the use of collective investment trusts (CITs), also known as commingled funds, collective investment funds or collective trust funds, is growing.
A long-time popular choice of defined benefit (DB) plans, CITs have increasingly become a choice of defined contribution (DC) plan sponsors in recent years. As investment expense is generally the largest single expense associated with a retirement plan, lower-cost vehicles, including CITs, provide plan sponsors and participants the potential for considerable savings as the industry becomes more focused on driving down plan costs to enhance performance and avoid fee litigation.
The potential pricing flexibility and cost advantages that CITs offer when compared with other investment vehicles are translating into greater demand in the DC market:
- CITs in DC plans have grown by 68% since 2008, with assets rising to more than $1.5 trillion by the end of 2014.1
- Of the 100 largest corporate DC funds by vehicle in 2016, CITs make up 54.3%, more than mutual funds, separate accounts and ETFs combined.2
Understanding the potential benefits of CITs, and how they differ from traditional mutual funds, can help DC plan committees determine if transitioning to CITs would be to a plan’s advantage.
CITs are tax-exempt, pooled investment vehicles maintained by a bank or trust company exclusively for qualified plans, including 401(k)s, as well as for certain types of government plans. They are similar to mutual funds, but with important differences. Like mutual funds, CITs are designed to facilitate investment management by combining assets from eligible investors into a single investment portfolio (i.e., a “fund”) with a specific investment strategy. However, collective trusts are exempt from the investment company registration requirements of the Investment Company Act of 1940 and the securities registration requirements of the Securities Act of 1933. These exemptions apply since collective trusts can only be offered by a bank to certain qualified employee retirement plans, and are not available to the general public. This does not mean that CITs are unregulated; CITs and respective bank trustees are supervised by the Office of the Comptroller of the Currency (OCC), or a state banking regulator, depending on the type of bank.
CITs can include any of the investment assets that are in mutual funds, they can be actively managed or index funds, funds of funds (FOFs), or non-traditional, such as REITs. CITs are particularly useful in single-manager or multi-manager FOFs, such as asset allocation (target risk or balanced) and target date funds (TDFs). These investments are growing in popularity due to their designation as Qualified Default Investment Alternatives (QDIAs) under the Pension Protection Act (PPA). Today, the CIT structure is increasingly deployed in TDFs — often in an open-architecture approach giving plan sponsors a means of creating custom glide paths for their participant population at an affordable price.3
Like other investment vehicles, CITs must follow ERISA regulations and are subject to rules of the Department of Labor (DOL). Each fund is managed and operated in accordance with the applicable trust’s governing documents, which generally include a declaration of trust (or plan document) and the fund’s statement of characteristics. Under ERISA, plan sponsors must disclose their arrangements with CITs on their 5500 forms and participants must receive at least quarterly notification of their positions.
FEE & FLEXIBILITY ADVANTAGES
Lower costs or fee advantages are a clear benefit of CITs over the mutual fund approach. In comparison to mutual funds, CITs typically have lower administration, marketing and distribution costs:4 because CITs are not subject to oversight from the U.S. Securities and Exchange Commission (SEC), they do not incur some of the expenses associated with compliance and regulatory reporting. There is no need to support the marketing and distribution of the fund into the retail space (e.g., producing prospectuses and maintaining retail call centers). Participant recordkeeping generally is at the plan level, rather than the CIT level, which can allow greater flexibility on recordkeeping structure and costs. This can all result in both lower initial and ongoing operational costs. As a result, CIT fees can be 20 to 25 basis points less than mutual fund fees.5
Plan sponsors interested in securing lower plan fees are also attracted by an ability to negotiate investment management fees and, in most cases, plan asset (or TDF asset size) minimums. As CITs do not have 12(b)-1 fees, DC plans looking to reduce or eliminate revenue-sharing and shift to a per-person administrative fee model are gravitating to this investment vehicle option. Both factors help to drive CIT growth: according to Callan Associates, 71% of DC plans offered at least one CIT in 2015, up from 60% in 2014.6
The shift to collective trusts offers additional benefits beyond lower fees. While CITs are by definition collective vehicles, they can be created specifically for large institutional investors. Plan sponsors also like the flexibility CITs can offer in terms of pooling together assets across multiple plans, often a common goal of large organizations with a history of M&A activity.
THE EVOLUTION OF CITs
While CITs have been used for more than 75 years, improved features have helped fuel their rise in DC plans. In 2000, CITs began trading on the National Securities Clearing Corporation (NSCC) Fund/SERV® platform, allowing automated trading and daily valuation, putting CITs on an equal footing with mutual funds for ease of investment. The PPA’s designation of CITs as accepted QDIAs gave a tailwind to the investment vehicle in 2006. Over the past few years, providers have addressed many of the early limitations of CITs, including lowering qualifying plan minimums to allow smaller plans access to the fee-advantaged investment option, and enhancing fund information with fee, risk and performance transparency to participants.
In the past, plan sponsors were hesitant to consider CITs due to a perceived lack of information for participants on the risks and performances of holdings (CIT investors do not receive an SEC-required prospectus, CITs do not have ticker symbols, and ratings from independent research firms were generally not available).
While CITs generally have less frequent and less complex shareholder reporting requirements, DOL Rule 404a-5 requires plan administrators to standardize strategy, risk, performance and expense disclosures of all investments (including CITs) to help participants make better- informed decisions. With advances in technology and increased usage, CITs have evolved to offer greater transparency and education to participants via third-party data aggregators (such as Morningstar®) and enhanced CIT provider data reporting and fund fact sheets available online and through plan call centers.
CITs continue to grow in popularity for a variety of reasons, including recordkeeper acceptance, consultant familiarity, pricing flexibility, daily valuation, NSCC Fund/SERV® compatibility and improved reporting and transparency as a result of compliance with DOL disclosure requirements under ERISA. Plan sponsors also appreciate that CIT trustees are subject to ERISA fiduciary standards with respect to ERISA plan assets invested in CITs.7
Together with the plan’s advisor/consultant and ERISA attorney, plan sponsors should consider the following questions to determine whether transitioning to CITs within the plan’s investment lineup would benefit the plan and participants:
- Is the plan provider’s current investment universe appropriate?
- Is the cost structure appropriate given the plan size, the services provided and the scope of desired investment options?
- Is there an opportunity to customize fees based on plan needs?
- Would the plan benefit by switching some asset categories to CITs due to cost-or fee-adjusted performance?
- What type of data and/or reporting will be supplied to the plan?
- What communications, education and information will be supplied to plan participants? In what format?
- Are there any liquidity boundaries, trading issues or operational considerations?
- How experienced is the asset manager, and what is the firm’s reputation in the marketplace?
- Given all available information, is the investment vehicle the best fit for the plan participants and their beneficiaries?