Collective Trust Clout.
Summary paragraph: Custom CITs have advantages, but monitoring them can be a challenge
The focus on fees has helped lead 401(k) plans to increasingly consider collective investment trusts (CITs), often in a customized way. Because CITs are open to institutional investors only and are free from some regulatory requirements, the costs tend to be lower than for off-the-shelf mutual funds. But, as with any investment, plan sponsors need to monitor those trusts, a process that differs somewhat from evaluating mutual funds.
Morningstar Retirement Solutions sees large defined contribution (DC) plans using customized collective trusts more and more frequently to put together white-labeled investments, says Jeremy Stempien, director of investments for the firm. A sponsor uncomfortable with offering an emerging-markets equity fund, for instance, can, instead, set up a collective trust fund-of-funds that divides the allocation between two managers -- an international one and an emerging-markets one. Or, if a sponsor does not want to offer a stand-alone commodities fund, it can create a customized collective trust focused on real return asset classes, mixing collective trusts focused on real estate investment trusts (REITs), Treasury inflation-protected securities (TIPS) and commodities.
Using a customized fund-of-funds approach with collective trusts also can give a plan access to managers it might not otherwise have, says Mary Beth Glotzbach, Morningstar senior vice president. Plans have to be large, however. "[These are] typically plans with at least $750 million in assets. But there is some interest among plans at the $500 million to $750 million level," she says.
Since collective trusts are regulated differently than mutual funds, in terms of information availability the former pose more of a challenge, says Marcia Peters, chief investment officer at adviser Portfolio Evaluations Inc., in Warren, New Jersey. "Because they are not required to produce the same disclosure, you cannot necessarily just pull up a document," she says.
Historically, collective trusts have had less transparency than mutual funds, Stempien says, but that gap has shrunk considerably in the past decade. Still, to monitor a collective trust effectively, a sponsor or its adviser must, in some cases, arrange upfront with the provider to have it supply the specific information the sponsor needs.
"Collective trusts are recognizing that they are in [a] world that is demanding more information," Peters says. "But one of the risks with collective trusts producing more information is that there may be a tendency for people to rely on the information that is given online and not ask questions. They may not be providing you with information as detailed as what you need."
Whether monitoring a CIT, a mutual fund or a separate account, Peters says, Portfolio Evaluations goes through an annual in-depth analysis. It sends out a detailed questionnaire to investment providers once a year to inquire about their performance and fees, among other things.
As sponsors monitor collective trusts, they may be able to arrange a better fee deal. Unlike mutual funds, collective trusts have negotiable fees. The fact that plans have an automatic stream of steady cash gives sponsors considerable leverage on fees, says Lori Lucas, defined contribution practice leader at Callan Associates Inc. Therefore, when going into a collective trust, they can negotiate, at the outset, a fee schedule that lowers participant fees as assets increase.
Rod Bare, a Chicago-based defined contribution consultant at Russell Invest-ments, suggests benchmarking the fee schedule annually. A sponsor can also ask a consultant to conduct a fee analysis, often done using commercially available databases from companies such as Morningstar and eVestment Alliance.
Experts also recommend that sponsors compare the collective trust fees to similar mutual funds. "A sponsor needs to look at what ... the fees [are] for the other vehicles for that strategy," Stempien says. The historical data finds that collective trusts can run a little cheaper, he says, but the gap between a collective trust and an institutional share class of a mutual fund has narrowed.
A sponsor may want to take the fee-for-value analysis a step farther and consider a request for proposal (RFP). Given the heightened regulatory oversight and legal cases focused on retirement plan fees, it makes sense for sponsors to resort to an RFP on occasion to check market prices and dynamics, says John Siciliano, a senior adviser at Greenwich Associates, in Stamford, Connecticut.
Expect to find a collective trust market still dominated by a small number of major players, Siciliano says. "It is not exactly a market area that people are piling into. It is a volume business," he says. "The collective trust business does not enjoy the same level of profitability that the fund managers enjoy. It is a less expensive format than a mutual fund, and a lot of collective trusts get formed just for that reason," one example being by very large corporations with 401(k) plans. Some plans, too, negotiate a "most-favored nation" provision in their contract, meaning the collective trust provider is limited from offering a better price to another client substantively the same size as that plan or smaller, he says.
Plans often go to rebid every few years, Siciliano says, and he sees potential to make a better CIT deal, despite the limited number of major players. "In this day and age, everything is so competitive," he says. "That is because the DC space is the only growing space left."