As the impact of the fiduciary rule, fee compression, and numerous class action lawsuits by employees against plan sponsors factor into decision-making by plan consultants and sponsors alike, a “what’s old is new” product has re-emerged as the go-to vehicle: collective investment trusts. Whether they offer a mutual fund or not, many advisers are considering collective investment trusts as another means to expand their distribution capabilities in a profitable manner.
Pooled Investment Vehicles Organized as Trusts
Collective Investment Trusts (“CITs”), sometimes referred to as Collective Trust Funds (“CTFs”) or Collective Investment Funds (“CIFs”), have been around for decades and were the standard choice for bank trust departments before mutual funds took center stage. In years past, CITs lost some of the spotlight to more prominent structures that are able to attract a broader array of assets, particularly mutual funds and ETFs. However, CITs have made a comeback in recent years for several reasons:
CITs moved to daily valuation, just like mutual funds;
CITs now trade on the NSCC platform, just like mutual funds;
The Department of Labor stepped in a couple of years ago and required more fee disclosure to plan participants. This pushed plan sponsors to find ways to lower costs for their participants. Most often, CITs offer a lower cost alternative to mutual funds;
Fee compression, driven in large part by the Department of Labor’s expected steps to further increase expense transparency, will only increase, thus increasing the attractiveness of the CIT structure;
There have been multiple plan participant lawsuits targeting plans that did not provide lower cost investment options, such as CITs;
There is more focus on the fiduciary responsibilities of the plan sponsors to better select investment options. CITs introduce a fiduciary in the form of a trustee, and the adviser carries a fiduciary responsibility to the trust, rather than the plan;
Morningstar began to track CIT performance, facilitating easier screening;
The trustee services required by CITs moved beyond the large banks as specialty providers emerged, bringing costs down and service levels up;
CITs do not have the same infrastructure requirements as mutual funds, thus the breakeven point for advisers may be substantially lower, which allows advisers to bring strategies to market that may not initially attract the requisite assets for a mutual fund;
CITs are regulated investment structures, but the trust companies creating the CIT are overseen by the Office of the Comptroller of the Currency (the “OCC”). In large part, the interaction with the OCC from a regulatory perspective is handled by the trust company, eliminating much of the burden on the adviser;
New CITs can be organized quickly, with minimal expense. Trust companies can work with an adviser to set up a new CIT in 30-60 days, versus 4 to 6 months for a mutual fund.
CITs have become a standard part of the menu in 401(k) plans. A recent study by Callan Associates (Callan Associates 2017 Defined Contribution Trends report) noted that CITs had gained ground on mutual funds. The study showed that nearly 65% of ERISA plans utilized CITs in 2016, up from 60% in 2014.
Benefits of CITs
So, how can you best capitalize on the opportunity? First, evaluate the distribution landscape and determine if your firm has inroads to the market, which is broadly defined as ERISA plans. For many boutique advisers, relationships already exist with companies, consultants, and referral sources, such as attorneys and CPAs that offer or provide services to these plans. Indeed, for many advisers, CITs were created initially to satisfy the need of an advisory client to make the strategy available to their employees. In other instances, larger plans may want to customize the strategy to include company stock or exclude competitor stocks. These requirements are less costly to meet in a CIT versus a mutual fund, and far more attractive to the plan sponsor and administrator than a separately managed account. Start with your own centers of influence and assess the demand. Arranging timely funding of a new CIT is a core component of a successful launch; completing this legwork up front will result in a more successful venture.
Trust Structure
As previously noted, CITs are generally less expensive than mutual funds because the infrastructure is simpler. To summarize the structure, a trustee (a registered trust company) oversees all aspects of the fund(s) rather than a fund Board. The legal structure (a trust) is simple to create and can be shared by multiple funds. The trustee acts as the adviser and names sub-advisers for each fund, typically the adviser initiating the formation of the CIT. One of the benefits of a CIT is that the trustee does much of the heavy lifting, which is a significant contrast to mutual funds. The sub-adviser, which is the firm precipitating the CIT launch, is primarily left to manage the portfolio and support the distribution effort. The offering document is created by the trustee, with input from the sub-adviser, for plan sponsors and is somewhat similar to an offering memorandum in a private offering.
Key Differentiators
Beyond that, the only services and expenses are for fund accounting, transfer agency, custody, and audit. Because the requirements for each service are less rigorous than mutual funds, they also tend to be slightly less expensive. Additionally, CITs can have multiple classes and may include a trail similar to a shareholder services fee. Different classes within a CIT can also contain different expense ratios and management fees, which is an attractive differentiator to mutual funds. The sales process for CITs tends to revolve around direct interaction with companies, consultants and influencers. This process can be less costly to advisers than mutual fund distribution activities.
Understanding the Product Limitations
As with all such products, there are some downsides. CITs may only be used in ERISA eligible plans such as 401(k), 403(b), 457(b), profit sharing, target benefit and defined benefit. They are not the answer to the traditional small account problem. Second, unlike a mutual fund, a departing employee cannot take their investment with them (unless, of course, the adviser already has a mutual fund with a similar strategy available). Finally, while performance cannot be advertised, it can be tracked through Morningstar.
With the CIT comeback now in full force, it may be a good time to evaluate your business strategy. A CIT offering can present another valuable tool to drive growth and deliver additional AUM to your firm at a relatively low cost; a close evaluation of your firm’s business model to ensure strategic fit, as well as proper planning and resourcing, will ensure that your firm seizes its share of this vast opportunity.
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