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Retirement Plans Take Second Look at a Cheaper Alternative to Mutual Funds

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Plan sponsors who wrote off using collective investment trusts in their retirement plans in the past should reconsider the products, as they have evolved to address many of their concerns, according to a paper by Portfolio Evaluations Inc.

CITs are not available to individual investors, so they can only be accessed through qualified retirement plans, according to PEI, a retirement plan consulting firm with more than $50 billion in assets under advisement. The Pension Protection Act allowed sponsors to designate CITs as the qualified default investment alternative in their retirement plans. However, many plan sponsors have declined to use CITs because although they are similar to mutual funds in several ways, some key differences made them difficult to adopt.

For example, CITs are not regulated by the Securities and Exchange Commission. Instead they fall under the purview of the Treasury Department’s Office of the Comptroller of the Currency. Although that oversight helped CITs keep costs lower than mutual funds, they were also less transparent, according to the report.

That has made plan sponsors leery of using the funds in the past, according to PEI, as well as increased difficulty filing Form 5500 and concerns about participants’ experiences with the products.  

Because they aren’t traded on an exchange, CITs don’t have a ticker and don’t have to be priced daily. In fact, the paper noted that several years ago, they were priced monthly and have since moved to daily pricing to accommodate investors and sponsors.

“As the popularity of CITs grows, so does the recordkeepers’ ability to provide communications and education materials for CITs in the same format and detail as they provide for mutual funds,” according to PEI. “For example, providers are able to create fact sheets, which are very similar to those created for mutual funds, and deliver these to plan recordkeepers, creating a seamless experience for participants to find information on both mutual funds and CITs from the plan website.”

Unlike the CITs of the past, today’s offerings frequently offer tiered pricing with revenue sharing arrangements that allow sponsors to offset their costs. At the same time, though, revenue sharing has become less popular, as efforts have increased to make pricing more transparent for investors, the paper noted. “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,” according to the authors.

Some CITs have anti-dilution provisions that require plan sponsors to pay to move assets in or out of a plan when it reaches a certain size, the paper noted.

Another drawback is that when participants leave a plan, they won’t be able to roll their assets into a similar vehicle since CITs aren’t available to individual investors. As the products have evolved, usage has grown. As of 2008, assets in CITs reached $9 trillion, according to Morningstar. Reuters reported in March 2015 that 60% of defined contribution plans offered CITs in 2014, up from 52% the year before.

PEI maintains a database of over 30 of the largest target-date fund providers and found that mutual funds are the preferred vehicle for offering TDFs. A third of providers in the database offer mutual fund TDFs only, according to the paper, but four have launched TDF CITs in the past two years.

All of the providers that use purely indexed strategies offer a CIT. “CITs are more common for indexed products, as they align with the fee-conscious objective of many indexed fund investors,” the paper noted, and indexed TDF CITs tend to be more similar to mutual fund TDFs than active or hybrid CITs.

Hybrids are more common, though, with 12 of the providers in the database offering a TDF CIT that combines active and passive strategies. Some providers that offer active mutual fund TDFs use a hybrid strategy for the CIT version, “opting to replace select actively managed underlying funds with passive strategies to lower both costs and active risk, thus appealing to a more institutionally minded client base.”

— Read Investors Paid Lowest Fund and ETF Fees Ever in 2015: Morningstar on ThinkAdvisor.