Shake up your clients' 401(k) with this tool
Online firms such as Betterment claim that they will shake up the 401(k) industry with their new digital offerings.
But the retirement industry has been experiencing a mini shake-up for the past decade, featuring an investment tool that has been around since the 1920s.
Collective investment trusts have been gaining in popularity as an alternative to mutual funds and other investment vehicles. These trusts are able to invest in almost-identical holdings as mutual funds but for a fraction of the price.
For those unfamiliar with a CIT, it is a “pooled investment vehicle organized as a trust and maintained by a bank or trust company,” according to a 2015 white paper, released by the Coalition of Collective Investment Trusts.
As these trusts can pool together various investments, they can mimic a mutual fund in approach and design, yet they can bypass Securities and Exchange Commission registration and requirements as they are only available to certain retirement plans and not retail investors.
In this important distinction, CITs can do away with various marketing, distribution, registration and disclosure requirements. This cost savings is passed on to the holder of the CIT (the plan sponsor and participant), making the trusts cheaper to own than a mutual fund but often holding near-identical assets.
TOO GOOD TO BE TRUE?
Is this too good to be true? Almost.
Before the recent increase of CIT usage, some plans deliberately steered clear of them. Infrequent portfolio data and lack of access to performance didn’t make CITs a popular choice, given that mutual funds were reporting these data on a daily basis.
Also, when plan participants have requested documentation on the CITs, a request needed to be placed with the trust itself to provide the most recent data. Mutual funds are required to issue this information on a scheduled basis and make it publicly available.
However these issues have been resolved. With the continued rise in use of CITs, technological advances, and the 2012 Department of Labor regulation governing fee disclosures, companies such as Morningstar have been able to access portfolio and performance data more frequently to provide to plan sponsors.
The increased confidence in these vehicles has been reflected in recent survey data from plan sponsors.
According to a Callan Associates survey issued in 2015, the number of plans between 2012 and 2014 offering mutual funds as an investment choice remained steady, marginally decreasing from 92% to 88.2%.
By contrast, the use of CITs rose from 48.3% to 60% during the same time period. Coupled with increased transparency and already low fees, plan sponsors have been making these funds more available to their participants.
This affects advisers and clients in several ways:
1. Understand the distinction between mutual funds and CITs. Being able to explain to clients why they shouldn’t use the mutual fund and instead select a CIT requires the ability to explain the differences between the trusts and mutual funds in layman’s terms. Advisers should point out that, though there are some structural differences in the investment vehicles, when the hood is raised, they are in fact very similar.
2. Embrace the trend. The use of CITs has been increasing over the past five years. Given recent DOL regulations, that won't slow down. As these investments aren’t available to retail clients and only to retirement plans, they have a long-term perspective in their design. It makes them a good match for long-term client investments.
3. Do your research. Even though many trusts have updated their practices to be close to that of mutual funds, advisers should explore the CITs that they wish to use.
Important things to consider include: Does the trust pricing change daily or less frequently? Over what periods does performance get reported, and when does that become available? Are there fact sheets that can be pulled up immediately, or does a request have to be made for information? Are the data provided backed up by that of a third-party processor (i.e. Morningstar)?
Take caution, too, as CITs may still not be the best option for many clients. The expense ratios of CITs across various asset classes range from 0.35% to 1%, below that of mutual funds that range from 0.55% to 1.25%.
If a client’s 401(k) allows the use of an index mutual fund, then that fund’s price may be much lower than that of a CIT. Using an index fund for some (or all) of the portfolio may be more appropriate than using CITs and actively managed mutual funds.
This story is part of a 30-day series on preparing for retirement. This story was originally published on Dec. 7, 2015.