A Fiduciary’s Guide to CITs: 4 Common Misconceptions
Collective Investment Trusts (CITs) are pooled investment vehicles, available exclusively to qualified retirement plans. They have become attractive alternatives to mutual funds due to their cost-effective access to institutional-grade investments.
CITs make up 30% of defined contribution plan assets, double from a decade ago. As their popularity continues to grow, plan sponsors must understand the nuances that accompany these vehicles. Plan fiduciaries should be aware of several misconceptions surrounding CITs to evaluate and monitor their inclusion in employer-sponsored retirement plans properly.
Misconception 1: All Mutual Funds and CITs are Created Equal
Just because a CIT and a mutual fund have the same name and employ the same strategy does not mean they are identical. Mutual funds and CITs have distinct legal and regulatory structures. The Securities and Exchange Commission (SEC), under the Investment Company Act of 1940, regulates mutual funds, while banking authorities, such as Office of the Comptroller of the Currency (OCC) or a state banking authority, regulate CITs, as they are bank-maintained trusts. This means CITs do not have a public ticker symbol or a standardized prospectus.
Misconception 2: Lower Fees Always Lead to Better Net of Fee Returns
CITs are typically offered at a lower cost than their mutual fund counterpart. This is for a few reasons, including avoiding SEC registration, disclosure, and marketing costs. CITs can come with tax advantages, especially in international investments, leading to savings. Therefore, switching to an “identical” investment vehicle with lower fees than its mutual fund counterpart sounds like a no-brainer.
One would expect that with lower fees, the CIT would have better net-of-fees performance. However, CITs do not always outperform mutual funds, and their success depends on a multitude of factors. The differences in allowable investments, cash flows, and legal involvement from the plan sponsor between mutual funds and CITs can lead to negative tracking error (performance differences between the CIT and the mutual fund). Depending on the specific CIT’s trust structure, it can be restricted from allocating assets to certain investment types. Examples that could be restricted from investment include commodities, direct real estate, pre-IPO securities, and below-investment-grade, non-agency residential mortgage-backed securities.
Additionally, because CITs tend to have fewer investors given their institutional nature, when plans enter or exit the CIT, it can impact the manager’s effectiveness in deploying and trading that cash. Given the recent increase in CIT adoption, managers must deploy many inflows appropriately, which can be tricky. It is also important to note that there are typically legal fees to review the additional contracts and paperwork that come with CITs. Overall, CITs may have lower fees, but the differences between the vehicles could lead to worse performance. Fiduciaries should evaluate CIT’s performance in a variety of time periods against its mutual fund counterpart as well as applicable peer groups and benchmarks. When negative deviations exist, it is important to understand why and whether they are short-term.
Misconception 3: Information Available to Participants is Identical Between CITs and Mutual Funds
It can become particularly tricky for plan participants to find information on CITs in their investment menu, as they do not have a familiar ticker symbol or the same public disclosure requirements as mutual funds. Under the Employee Retirement Income Security Act (ERISA), fiduciaries must provide participants with sufficient information to enable them to make informed decisions about their retirement plan investments. Proactive communication strategies surrounding CITs are important. Plan sponsors should lean on their advisor and recordkeeper to help communicate what a CIT is and how it may differ from the mutual fund a participant may currently hold. CIT-specific fact sheets can be posted to your recordkeeper’s website, which can be helpful for participants.
Misconception 4: CITs are Available to All Retirement Plans
CITs are strictly eligible in tax-qualified retirement plans like 401(k)s and 401(a)s and cannot be used in IRAs or non-qualified plans. It is also important to note that 403(b) plans cannot utilize CITs at this time. These nuances are important for fiduciaries to know when determining the best fit for the specific types of plans offered to their participants.
The Importance of Diligent Review
CITs can add value to a retirement plan investment lineup, but plan sponsors should exercise caution. Their unique regulatory and structural characteristics demand thorough due diligence and detailed diligence documentation. Plan fiduciaries must look beyond a CIT’s fund name to understand all facets of a CIT and evaluate its appropriateness for their plan(s) and participants.
SEE ALSO:
• Democratizing Retirement Investments: The Rise of Collective Investment Trusts
• Plan Sponsors Consider CITs for Private Market Exposure
• Ascending SECURE 2.0: Catch-Up Contributions
Sydney Aeschlimann, QKS, is a Manager on the Retirement Plan Practice Group, a specialized team at Innovest Portfolio Solutions that maximizes efficiencies and implements process improvements for retirement plan clients. She also supports the Research, Due Diligence, and the Performance Reporting Team.
Ian Gilbert is an Analyst on the Research and Retirement Plan Teams at Innovest. His responsibilities include monitoring investment products and strategies, creating deliverables for retirement plan clients, and completing quarterly performance reports.
Taylor Truitt is an Analyst Assistant on the Research and Retirement Plan Team, as well as Performance Reporting Team at Innovest. Her responsibilities include creating deliverables for Innovest’s retirement plan clients, monitoring investment products and strategies, modifying Investment Policy Statements, and completing quarterly performance reports.