Collective investment trusts find renewed popularity as alternative to mutual funds
Amended with clarification
Launched two years before the Wall Street crash of 1929, collective investment trusts are making a comeback in 401(k) plans, offering a lure of lower fees and greater flexibility in investment options.
“The impression we have is that CITs are continuing to gain momentum,” Steve Deutsch, director of collective trusts and separate accounts for Morningstar Inc., Chicago, said in an interview. “The products are being given more focus by money management firms,” which are lowering investment minimums and adding target-date funds to the CIT menus.
Mutual funds now dominate 401(k) plans, but CITs have been gaining market share, according to Cerulli Associates, Boston. CITs had 17% of the market in 2005 vs. 45% for mutual funds. By 2008, the CIT market share was 20.9%, while the mutual fund share was 44.6%.
In the early days of 401(k) plans, CITs “greatly outnumbered” mutual funds as investment options, said a recent Cerulli Associates report. At that time, the typical CIT was valued quarterly and provided “only a limited disclosure statement” about investment strategy, said the report. Mutual funds surged ahead by offering daily valuation and “superior” disclosure to clients, the report said.
Now, however, most CIT offerings can be valued on a daily basis, administration costs have dropped, and product customization has provided a stiff challenge to mutual funds, Cerulli said.
The momentum driving greater interest in CITs is propelled by prospects of lower costs, Mr. Deutsch wrote in a recent analysis of the CIT market. These include “reduced marketing expenses, no 12b-1 fees, no time and cost of independent boards, no Securities and Exchange Commission and state filings, no prospectuses (and a) lower record-keeping burden,” he wrote.
Other benefits include the ability of plan executives — especially from large plans — to negotiate prices and to customize investment options, he said. Some 45% of DC plans use collective investment trusts, according to Morningstar's estimates. Among those with at least 1,000 participants, 70% do.
The passage of the Pension Protection Act and the prospect of more fee-disclosure regulations are some reasons CITs could increase in popularity, said Richard A. Davies, senior managing director for defined contribution services at AllianceBernstein (AB) LP (AB), New York, which manages $4.7 billion in CITs.
“Plan sponsors are becoming more sensitive to costs,” said Mr. Davies, adding that rules governing CITs enable a more “streamlined” cost structure vs. that of mutual funds.
Intel Corp., Santa Clara, Calif., made a big commitment to CITs in its two DC plans. In its $4.43 billion profit-sharing plan, CITs account for 72% of assets. In the 401(k) plan, CITs represent 22% of the $4.36 billion in assets, said Stuart Odell, assistant treasurer for retirement investment.
“Fees are a big part of it, but the other piece is flexibility,” he said. Intel can invest in a CIT that tracks the S&P 500 index at a fee under one basis point, less than half the cost of the least expensive mutual fund institutional share for the same index.
Intel started using CITs in the mid-1990s because they offered investment options that replicated certain indexes, such as the Russell 1000 Value and Nasdaq 100, that weren't available in mutual fund formats, Mr. Odell said.
Intel also offers customized target-date funds via CITs. “You can't do that with an off-the-shelf '40 Act fund,” he said.
“Our target-date funds consist of multiple underlying managers,” he explained. “We are able to maintain the overall structure of the target-date fund, but we have the flexibility to add managers (or) asset classes without having to change the entire fund or family of funds.”
Cost was the motivation for Akzo Nobel Inc., Chicago. CITs now account for about 11% of its $1.2 billion in DC assets, said Jaime Erickson, manager of defined contribution plans.
A 2008 fee study to determine whether the plan could offer similar investment opportunities for lower costs prompted AkzoNobel to replace target-date funds from Fidelity Investments with a CIT target-date family offered by Barclays Global Investors, now BlackRock (BLK) Inc. (BLK)
The then-BGI fees were 15 basis points across the board; for the Fidelity Freedom fund family, the cost ranged from 40 basis points to 90 basis points, she said.
CITs are being marketed to small plan sponsors, too, for investment versatility. “Our typical plan sponsor has 100% of assets invested in CITs because CITs allow them access to institutional money managers, ETFs and mutual funds,” said Ian Sheridan, chief executive of First Mercantile, Memphis, Tenn., which manages $4 billion in CIT assets. “We're seeing a lot of growth and interest” in sponsors with DC assets of $30 million or less.
Some regulatory differences between CITs and mutual funds have caught the attention of Andrew J. Donohue, SEC director of the Division of Investment Management. “Collective investment trusts are regulated by the banking agencies and may rely on an exclusion from registration under the Investment Company Act,” he said in a speech last month at the Practising Law Institute's investment management program in New York. “The premise underlying this exclusion is that banks exercise full investment authority over the pooled assets, among other things.”
Mr. Donohue said his division “is looking at whether, under certain conditions, this exemption is properly relied upon and consistent with the (Investment Company) Act and whether it denies investors appropriate protections.”
Although he said his remarks were his own and didn't necessarily reflect views of the SEC or commission members, he concluded: “As we learn more about the structure and operation of these platforms, we will be considering ... whether there may be a need for any regulatory recommendations.”
There are some drawbacks to CITs. For example, participants can't make relative comparisons with the same ease as they can with mutual funds, Morningstar's Mr. Deutsch said. “Participants can't go to a third party, which makes the participant reliant on the sponsor.”
Fact sheets provided by the plan might give only the top 10 holdings and provide only a preferred benchmark, rather than one offered by a third party, Mr. Deutsch added. Participants accustomed to checking ticker symbols and reading prospectuses may be flummoxed by the lack of both for CITs.
Some concerns about CITs are being mollified by advances in technology or improvements in communication, but participant education still is necessary.
When Akzo Nobel changed its target-date fund family to CITs, it sent a 20-page brochure describing the changes and explaining why the changes were made, said Ms. Erickson, the manager of DC plans.
However, a “small number of employees” were miffed when they couldn't find ticker symbols and had trouble finding more detailed information. As a result, she worked with the provider to create customized fact sheets posted quarterly on the Internet.
Before AllianceBernstein (AB) moved all of the $650 million in its own 401(k) plan to CITs in September 2007, it conducted focus groups to prepare its education effort. “When presented with the terms like "portfolio' or "investment trust' at the end of an investment name, many participants thought the product was very complex and ... that they needed to do something to create the portfolio,” said Cathy Peterson, senior DC communications director.
AllianceBernstein learned from the focus groups that the word "fund' “was clear and (that) most participants could relate it to something they know, which meant it was not a stumbling block for them,” Ms. Peterson said. Although it uses the word "fund,' AllianceBernstein makes clear the investment option is a CIT, providing a description of CITs, regulations and sources of additional information in its disclosure and fact sheets for employees, she said.