• Vitaly Novok

Collective Investment Trusts: Utilization is Growing but Challenges Remain



Driven by the desire to avoid any excessive-fee lawsuit, simplify the investment menu, and minimize investment expenses for plan participants, plan sponsors have implemented a few important changes to the investment menu over the last few years. Guided by behavioral finance principals, many plan sponsors have significantly reduced the amount of investment funds available to plan participants. This action alone has helped many plan participants avoid the paradox of choice, improve diversification, and as a result, increase the chances of meeting their retirement goals.


Another important step to help plan participants save more for retirement is to address investment expenses. This is not an easy nut to crack because 401(k) investment menus are dominated by mutual funds. And as we all know, investment companies are very reluctant to any changes, especially when it comes to fees being paid out by others.


The cobweb that is mutual fund compensation is very complicated. Even the introduction of DOLs 408(b) Fee Disclosure for retirement plans couldn’t fix the situation: hidden fees and expenses charged by mutual funds that are paid out of the plans’ and plan participants’ assets remained, essentially, invisible. The development of different classes of shares, such as I or R, was supposed to address this issue as some institutional shares don’t have any fees other than management fees built into them. But again, this solution didn’t have much of a positive effect on micro and small plan sponsors, as those shares require a minimum investment amount of $1 million on average.


Other players in the investment management arena did not stay idle, as they understood the difficult position that plan sponsors were in. With the help of retirement plan advisers, Collective Investment Trusts (CITs) were brought back to life and now account for 16% of all defined contribution investment only assets.



Moreover, according to a new study by ALPS, CITs could become the dominant investment vehicle in the defined contribution market.

What Are CITs and Their Advantages

Originally introduced way back in 1927, CITs, like mutual funds, are pooled funds run by banks and trusts for the exclusive benefit of qualified retirement plans. Compared to mutual funds, CITs have a few distinct advantages, with the greatest one being lower costs.

CITs are regulated by the Office of the Comptroller of the Currency or state banking regulators. As a result, the rules and requirements of the Investment Company Act of 1940 that regulates mutual funds don’t apply to CITs. For example, since CITs are available to institutional investors only (retirement plans in this case), there is no requirement to file with the SEC and advertising and marketing are not allowed. This effectively reduces compliance and marketing costs.

Based on the study by the ALPS, CITs have been growing at 7-year CAGR of 14.4%. A big portion of this growth is to the result of lower fees and operational expenses. The same ALPS study found that the relative cost savings of CITs over institutional and R6 class mutual funds is estimated to be in the 10 to 30 basis point range.

Another big advantage of CITs is that the exact fee structure is flexible and is directly negotiated with plan sponsors, whereas the fee structures for mutual funds are set by mutual fund managers. Fees tend to decrease as the assets grow, but this is not necessarily the case with mutual funds’ that usually have a fixed fee.

Challenges

One of the biggest concerns of the early days of CITs was a lack of transparency. Since CITs are not publicly traded vehicles, they were valued just once a quarter. This made things more complicated for conducting due diligence and monitoring performance. Needless to say, this has considerably changed. Today, CITs are valued mostly on a daily basis and plan sponsors can access their performance by visiting a bank’s or recordkeeper’s website. In addition to that, CITs data can be accessed via databases such as Morningstar.

Despite their aggressive growth, CITs remain limited to mostly large and mega plan sponsors. Large account minimums make it hard for CITs to be used among small plan sponsors. However, this trend has been changing recently. Per ALSP research, CITs have picked up some steam and seen some growth among small 401(k) plan sponsors as well. Account minimums have been decreasing and most likely this trend will continue.

Conclusions

Over the last few years, CITs have undergone major improvements which allowed them to gain a decent market share among retirement plan sponsors at the expense of mutual funds. Many 401(k) plan sponsors found CITs a great alternative for mitigating risk of a fiduciary breach, improving the investment menu, and minimizing investment expenses. The biggest advantage of CITs is their operational efficiency, which results in lower costs. Lower fees make CITs extremely valuable to 401(k) plan sponsors.

Moreover, the transparency issue has faded into insignificance. CITs don’t have a ticker symbol, which is annoying considering how easily accessible the information is nowadays. But valuations are available daily and databases like Morningstar making it possible to access CITs data at any time. However, a whole lot more needs to been done in this direction.

If you are considering adding CITs to your 401(k) investment menu, don’t base your decision exclusively on lower fees. Make sure you completely understand the contract between you and the trustee. Double check the following specifics:

  • If there are any wait periods when investing or exiting a CIT

  • How frequently does the CIT holdings are valued

  • When does performance reported, and

  • If the performance being reported to third-party databases like Morningstar


Finally, know your plan’s investment philosophy, goals, and demographics. Then, based on this information, compare fees of potential CITs to mutual funds. If your plan’s investment menu is going to be composed of mostly passive investment strategies that track various investment indices, then passively managed mutual funds may be a much better option for a variety of reasons.

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