CITs become preferred target-date series choice

As target-date funds continue to gain popularity and assets, those based on collective investment trusts are growing much faster than their mutual fund-based brethren, more than doubling their market share in six years.

"It's money," said Jason Kephart, a strategist on the multiasset and alternative strategies team at Chicago-based Morningstar Inc., describing a key attraction for choosing a CIT-based target-date fund vs. a comparable mutual fund-based target-date series.

"The performance tends to be similar" between comparable target-date series, but the CIT fees are less than the fees for mutual fund series, he said.

Mr. Kephart said the CIT structure and its regulatory requirements enable more flexibility for sponsors to negotiate fees.

Mutual funds must charge a stated expense ratio listed in the prospectus for each share class; but CITs have more leeway. "This makes CITs more attractive to larger sponsors," he said.

As a result, Morningstar's latest target-date industry annual report shows CIT-based target-date series with 43% of target-date fund assets last year vs. 18% in 2014. The CIT assets jumped to $1.18 trillion last year vs. $154 billion in 2014, according to Morningstar Direct. Mutual fund target-date assets more than doubled to $1.57 trillion from $703 billion during this period.

Because CIT data is less precise than mutual fund data — the former is provided by firms voluntarily to Morningstar — the CIT market share and asset size are likely larger than what Morningstar Direct is measuring, Mr. Kephart said.

He added that CIT-based target-date series could get a boost if Congress passes — and President Joe Biden signs — legislation, proposed in both the House and Senate, that would enable 403(b) plans to offer CITs.

The CIT advance also was underscored in an annual sponsor survey recently published by Callan LLC, San Francisco. Mutual fund-based target-date funds were used by 68% of respondents in 2010 while 22% used CIT-based series (the other respondents cited custom target-date funds or they didn't know). By 2020, the mutual fund target-date series offerings were down to 42% of sponsors while the CIT group was up to 41%.

The latest survey covered 93 sponsors, including clients and non-clients. About 61% had total assets of $1 billion or more.

As the number of CIT-based target-date funds has soared, the number of mutual fund-based target-date funds has remained stagnant in recent years.

There were 134 CIT strategies last year vs. 58 in 2015, according to Morningstar Direct. The number of mutual fund strategies rose to 57 from 54 during this period.

Mr. Kephart noted the overall yearly numbers reflect some ebb and flow in each category as some series are liquidated and others merge.

However, the recent rise in new CIT target-date series has been dramatic — 22 last year, 23 in 2019 and 12 in 2018, according to Morningstar Direct. Among mutual fund target-date series, there were four over this period.

Mr. Kephart pointed out that many of the new series are relatively small products often issued by trust companies in groups of three investment styles — aggressive, moderate and conservative. Still, some of the biggest names in asset management offered new target-date funds last year, including T. Rowe Price Group Inc., Nuveen and Pacific Investment Management Co. LLC.

T. Rowe Price was the third-largest provider of all target-date funds based on assets, as well as the third-largest provider of CIT target-date funds last year, according to Morningstar. The company added its fourth CIT target-date series in January 2020; it also has two mutual fund-based target-date series.

The newest CIT target-date series emphasizes active management with about 93% of underlying investments being actively managed. That's the same percentage as another CIT target-date series. The difference is that the newer series has a slightly lower equity exposure.

Another target-date series has an approximately 60% passive/40% active ratio and still another has a 20%/80% ratio of passive management to a combination of active management and enhanced index.

"The No. 1 driver is sponsors unbundling their expense structure" by moving away from revenue-sharing, said Joseph Martel, a Baltimore-based target-date portfolio specialist at T. Rowe. "They want to separate investment expenses from administrative expenses."

CITs also provide fee flexibility. The more target-date fund assets in a plan, the more a sponsor can negotiate fees.

Each CIT series has a sliding scale of fees vs. assets. For example, the CIT series with the 60/40 mix of passive and actively managed investments charges 46 basis points for a plan with $20 million to $100 million in target-date assets. If a plan devotes $4 billion to $5.5 billion in target-date fund assets, the fee is 19 basis points.

"In most plans, target-date funds are the largest assets," said Mr. Martel, referring to their prominent role as a qualified default investment alternative.

For institutional clients, the mutual fund target-date series require a $1 million minimum in target date assets, although this requirement may be waived under certain circumstances. Through January, the T. Rowe Price mutual fund series' aggregate assets were about $176 billion vs. the CIT aggregate assets of about $146 billion, he said. CIT assets have been gaining over the years through new money and through transfers from the mutual fund series, he added.

The glidepaths for all of the target-date series are the same — a "through" approach in which the ratio of equity to fixed income changes past the standard landing point retirement age of 65. Target-date funds using the "to" approach freeze the equity-fixed income ratio at the landing point.

Nuveen, the investment management arm of TIAA-CREF, entered the CIT target-date field in October 2019, with a series featuring a mixture of active and passive management, and again in December 2020, with an index-based target-date series. Both use the Nuveen TIAA Lifecycle brand and both use SEI Trust Co. as the trustee. CIT-based asset data wasn't available.

"There was strong demand," said Brendan McCarthy, the Boston-based managing director and head of DCIO.

TIAA-CREF offers two mutual fund-based target date funds — an actively managed one with $38.7 billion in assets and an index-based one with $34.2 billion in assets, both as of Dec. 31. These target-date funds, with the TIAA-CREF brand name, have been available long before TIAA-CREF acquired Nuveen Investments in 2014.

"A lot of drivers for CITs are cost, but there are other factors — transparency, flexibility and regulatory oversight," Mr. McCarthy said.

Although he said Nuveen's mutual fund-based index series is low-cost at 10 basis points, the CIT index series is even lower at 8. The latter requires a sponsor to have $100 million in target-date fund assets; the former has no minimum.

The actively managed mutual fund series charges 42 basis points. The CIT blend series charges between 26 and 28 basis point depending on the share class. There is no asset minimum for either series.

Underlying investments in the two index-based target-date series are the same, and so is the glidepath — a "through" approach that goes 30 years past retirement. The actively managed mutual fund series and the CIT blend series have the same glidepaths as the index-based series.

PIMCO added a CIT-based target-date series in May 2020 because "ultimately, the market demands and expects target-date funds to be in a CIT format," said Bransby Whitton, executive vice president and target-date fund strategist, based in Newport Beach, Calif.

The underlying investments in the CIT series and in a mutual fund-based series, launched in December 2014, are "nearly identical," combining active and passive management, he said. The glidepaths, which use a "to" approach, are the same.

The average cost for the mutual fund series is 22.5 basis points vs. 20 basis points for the CIT series.

Mr. Whitton said PIMCO needed a commitment from a sponsor to invest a minimum of $1 billion in target-date fund assets before launching its CIT-based series. The $1 billion minimum applies to any sponsor seeking the firm's CIT-based series.

For CITs, his company is "primarily focused on market segmentation, rewarding the larger plans for their (asset) scale," he said.

For the mutual fund series, "the minimum initial investment for institutional and administrative class shares is $1 million," a spokeswoman wrote in an email. "However, it may be modified for certain financial intermediaries who submit trades on behalf of eligible investors."

As of year-end, the CIT series had $1.1 billion in assets; the mutual fund series had $1.5 billion.