The Evolution of Collective Investment Trusts and Considerations for Plan Sponsors
Plan Sponsors have increasingly focused on finding low-cost investments and more transparent fee structures for their retirement plans, in part due to the increasing number of headlines related to fee-based litigation issues. While on occasion this leads plan sponsors to consider passive investment products, such as index funds, for their plan lineup, it can also induce conversations related to investment vehicle choice, such as considering using collective investment trusts (CITs) over traditional open-end mutual funds. This paper provides an overview of and trends surrounding CITs, in particular within the target date industry, and outlines what plan sponsors should consider when looking at adding CITs to their plan lineup.
OVERVIEW OF CITS
A CIT, also known as a commingled or collective fund, is a pooled investment vehicle used by defined benefit and defined contribution plans. Similarly to open-end mutual funds, CITs can be indexed or actively managed and can be invested in a broad array of asset classes. Unlike open-end mutual funds, which are regulated by the Securities and Exchange Commission (SEC) and must regularly report their full portfolio holdings and monthly performance, CITs are issued by banks or trust companies and are therefore overseen by the Office of the Comptroller of the Currency (OCC) (state-chartered banks that issue CITs are subject to their specific state’s regulations) and have very few requirements in terms of reporting and disclosure, thereby lessening their overhead costs
Table 1: Features of CITs versus Mutual Funds
|Characteristics||Collective Investment Trust||Mutual Fund|
|Open to Individual Investors||No||Yes|
|Open to Most Retirement Plans||Yes||Yes|
|Open to 403(b) Plans||No||Yes|
|Regulator||OCC or state banking regulator||SEC|
|Required Reporting||Declaration of Trust||Prospectus, proxies, statements of additional information|
|ERISA Disclosure Requirements||Same ERISA disclosure requirements (i.e. returns and expenses) for mutual funds and CITs||Same ERISA disclosure requirements (i.e. returns and expenses) for mutual funds and CITS|
|Form 5500 Filing||CITs used in defined contribution plans must provide fee disclosures to assist plan sponsors in completing Form 5500. The fee disclosure can be sent to the record-keeper or directly to the plan sponsor||Mutual funds provide the same kind of fee disclosures as CITs, but typically provide it to the record-keeper|
|Plan Level Portability||Some CITs have anti-dilution clauses in which plans pay the transition costs for large, sponsor-initiated cash flows into and out of the CIT||No issues|
|Participant Level Portability||CITS are not available to individual investors, so when participant leaves the plan (i.e., rollovers), the CIT option is no longer available||No issues in most cases|
|Share Classes||Different share classes possible||Different share classes possible|
|Investment Expenses||Typically less expensive||Typically more expensive|
|Participant Considerations||No ticker
Fact sheets similar to mutual funds
Most are priced daily
|Fee Structure||Most CITs are offered in net of fee structure; some charge operating and/or management fees to the plan||Net of fee|
GROWTH IN CITS
CITs have been gaining prominence. According to Pensions & Investments, assets invested in CITs have grown from $895.6 billion in 2008 to $1.51 trillion in assets at year-end 2014. CIT vehicles in the TDF space are also gaining in prominence. An important trigger for that growth was the Pension Protection Act of 2006, which stated that CITs were eligible to be used as a Qualified Default Investment Alternative (QDIA) within defined contribution plans. In addition, as plan sponsors are increasingly fee conscious, the option to elect a low-cost CIT as a default for participants holds appeal. For example, T. Rowe Price, a firm which offers target date funds in both CIT and mutual fund vehicles, reports that in the past 12 months, roughly $4.1 billion in assets have shifted from its flagship mutual fund series to its two CIT series.
EVOLUTION OF CITS
As CITs have grown in assets, there have also been strides in improving the plan sponsor and participant experience in using these vehicles. Historically, plan sponsors have been hesitant to offer CITs in their defined contribution line up for several reasons, including the following:
- Lack of SEC oversight
- Form 5500 filings were more difficult
- Concerns for a participant experience
- CITs did not have a revenue sharing component
However, several key shifts in the retirement plan landscape have helped CITs become increasingly retirement plan friendly, both for the plan sponsor and the participant.
While CITs, as they are not regulated by the SEC, are not required to distribute prospectuses or statements of additional information, CIT assets in a qualified plan are considered to be plan assets, and are therefore subject to ERISA disclosure requirements. These disclosure requirements are the same for mutual funds and CITs. Both CITs and mutual funds, for example, are required by ERISA to disclose performance, benchmark performance and expense information.
ERISA also requires plan sponsors to annually fill out Form 5500, which includes disclosures related to the financial status of the plan. Both CITs and open-end mutual funds used by defined contribution plans are subject to DOL and ERISA reporting requirements and must provide fee disclosures to the plan’s record-keepers (CITs may provide this information directly to plan sponsors).
Oversight by the OCC, rather than the SEC, has allowed CITs to achieve significant cost savings relative to mutual funds, however, until recently it also meant less transparency from the participant perspective. For one, because CITs are not traded on an exchange, CITs do not have to be priced daily. Several years ago, CITs were commonly priced monthly; today, to address the needs of plan sponsors and participants, most CITs have daily pricing, just like open-end mutual funds. In addition, some plan sponsors have cited concerns that since CITs do not have ticker symbols, participants would not be able to find information on these investments from public sources. While that remains true, the industry has made strides to make investment information more easily accessible. As the popularity of CITs grows, so does the record-keepers’ ability to provide communications and education materials for CITs in the same format and detail as they provide for mutual funds. For example, providers are able to create fact sheets, which are very similar to those created for mutual funds, and deliver these to plan record-keepers, creating a seamless experience for participants to find information on both mutual funds and CITs from the plan website.
Historically, CITs were almost always offered without a revenue sharing component. The lack of ability to offset recordkeeping expenses made CITs less desirable for defined contribution plans, who had to pay these costs out-of-pocket or charge an additional expense to participants, and record-keepers, who were typically paid from the revenue sharing component of investments. Today, CIT providers often are able to offer tiered pricing, incorporating a revenue sharing amount that can more closely align with plan sponsors’ needs. In addition, in line with the growing trend to make participant expenses–investment and administrative–more transparent and level across investments, more plan sponsors are looking for investment vehicles without revenue sharing. While mutual funds are also increasingly offering “zero revenue sharing” share classes, the simplicity and flexibility of CITs’ pricing, along with their often lower overall expenses, is driving their more recent increase in popularity.
Still, there are some unique differences between CITs and mutual funds that plan sponsors should be aware of. For example, CIT providers may have anti-dilution policies. An anti-dilution provision is a feature a provider may institute that will require a plan sponsor to pay the costs of moving assets in or out of the CIT if that asset size reaches a specific threshold. For example, some providers may charge transaction costs if plan assets are above a specific percentage of total CIT assets. Typically, this feature is only a concern if a plan sponsor is investing in a recently launched CIT or one without a significant asset size. In addition, since CITs are only available to institutional investors such as defined contribution plans, participants leaving a 401(k), for example, would not be able to rollover their assets to an identical vehicle outside of the plan. From a fee perspective, CITs can vary by how they charge operating and management expenses, which are included in the all-encompassing trustee fee. Some CITs deduct these expenses from CIT assets, while others do not deduct these expenses and instead each plan sponsor pays the bank or trustee company a set fee.
CITS FROM AN INVESTMENT PERSPECTIVE
Investment managers also differ in their approach to managing CIT and mutual fund assets, and plan sponsors should be aware of any differences in strategy across vehicle. For single asset class strategies, an investment firm will typically offer a CIT and a mutual fund version of the same investment strategy. In these cases, the CIT is typically managed by the same portfolio management team as its mutual fund counterpart and holds the same securities (stocks and bonds) as the mutual fund and in the same proportion. The performance and volatility for the mutual fund and CIT can therefore be expected to be very similar. However, for target date products, firms have taken several different approaches to launching CIT and mutual fund vehicles. While some investment firms offer an identical strategy in both a CIT and mutual fund vehicle, other firms have opted to launch CIT and mutual fund products with different goals or different methods of implementation, causing there to be significant deviations in participant outcomes. When searching across vehicles for a target date product, plan sponsors should be cognizant of the variability across providers.