Bank and trust-controlled collective investment trusts (CITs) may give retail mutual fund companies a run for their money in 401(k) and other defined contribution plans.
Although CITs, also referred to as collective funds or commingled funds, have been available to qualified plans for decades, plan sponsors have historically favored mutual funds for their daily pricing, broader distribution and disclosure.
But as fiduciaries begin looking more carefully at the cost of retail mutual funds-and as banks and trusts have widened the assortment of offerings and tapped into technology to erase concerns about operational efficiency and information access-CITs are enjoying renewed interest, according to a report by Phoenix-based AST Trust and Hewitt Associates of Lincolnshire, Ill.
"We're not saying that collective funds are going to take over the market, but we do think they are another choice for plan sponsors to consider, and that they are very competitively priced," said Steve Ferber, director of the collective trust division at AST, a company with a serious stake in the CIT market, with 1.5 billion under managment.
CITs are subject to banking regulations, not the Securities and Exchange Commission. As a result, investors may not receive the same level of reporting as they would from a mutual fund investment. In addition, they can be less expensive to operate.
In lieu of prospectuses, CITs issue shorter disclosure statements. CITs do not issue proxies, another costly process. CITs also do not incur advertising expenses, nor are they vulnerable to market timing or other abuses.
"There's a perspective by many employers that employees need to be able to look things up in the paper," said Pamela Hess, a defined contribution plan consultant at Hewitt.
AST and other banks have a serious interest in the ever-swelling retirement market, which the Investment Company Institute pegs at $16.4 trillion.
Since 2003, the dominance of retail mutual funds within defined contribution plans has been slipping. In fact, use of retail mutual funds within these plans has dropped from 65% of options offered to 54%, according to data from Morningstar of Chicago and Greenwich Associates of Greenwich, Conn.
No single product has taken their place, according to the AST report. Institutional mutual funds, separate accounts and CITs have each gained market share, with CITs gaining the most, with 41% of defined contribution plans offering CITs in 2006, up from 32% in 2003.
The market share, or at least the value of assets CITs control, is poised to grow significantly if the Department of Labor includes target-date and target-risk CITs among the investment vehicles considered as candidates for default investments under the 2006 Pension Protection Act.
"The PPA gave a second wind in institutions' comfort with using collective trusts in 401(k) plans," said Steve Deutsch, director of separate accounts and CITs at Morningstar.
For plan sponsors, the primary allure of CITs may be their cost to investors. Data from Hewitt shows the median expense ratio of a large-cap growth CIT is 56 basis points, compared to 93 for a similar style mutual fund.
Fiduciaries can also negotiate the price so that a sponsor of a $50 million plan may pay less than that of a $20 million plan, further pressuring the one-price-fits-all model of mutual funds.
"That tiered purchasing power can be really meaningful for employers," Hess said.
In the past, CITs had a reputation for limited offerings, and fiduciaries were concerned about offering their employees adequate options. That, too, has changed, Deutsch said. There are now more than 800 funds-many of them mirror images of mutual fund counterparts.
Today, mutual fund companies are getting into the game through acquisitions, such as when State Street purchased Investors Bank and Trust in July, or opening their own trust divisions, as Fred Alger Management of Morristown, N.J., did in 2002 when it opened Alger National Trust, Deutsch said.
Still, CITs face some hurdles with investors.
"Many employers are afraid to make the move because they fear investors will see it as a take-away, rather than an add-on," Hess said. Investor education, therefore, is paramount, she said. So is disclosure, added Robert B. Miller, a trial attorney who specializes in ERISA law at Bullivant Hauser Bailey in Portland, Ore. "When an investor directs his investments in a 401(k), the fiduciary is typically not responsible for the investment performance, but is always responsible for the choices," he said. And part of that responsibility includes explaining to participants exactly what their options are, and how they function.
The truth is, many plans already include CIT stable value funds, but they resemble mutual funds so seamlessly that participants and, sometimes, even sponsors do not realize their plans include the vehicles, Ferber said.
Access to information is less of a challenge than it was in the past for investors. Morningstar, for example, tracks 700 data points of more than 800 CITs, including information about underlying holdings, and gross and net monthly returns.
Recordkeeping challenges have also largely dissolved since 2000, when the National Securities Clearing Corp. added CITs to its Fund/SERV platform.
However, if an employee leaves his or her plan, the CIT cannot be rolled into an IRA. Nonetheless, Ferber said that he has not encountered an instance where rollover options have worried sponsors.
Again, the issue comes back to one of disclosure, Miller said. "Anything that is a limitation of any kind absolutely must be disclosed," he said.
Especially when using non-40 Act vehicles, he said, fiduciaries must review the menu of options regularly and make sure they are the most appropriate, responsible choices.
Most importantly, fiduciaries must explain to their participants why. "The paramount duty is to disclose all of this information," he said.
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