Seen by many as cheaper alternatives to mutual funds in the retirement plan space, collective investment trusts grew sharply in 2016, according to Cerulli Associates.
The Boston-based research and consulting firm pegged assets in CITs at $2.8 trillion, representing an 11.6 percent annual increase, which fueled additional interest (and investment) throughout 2017 and into the beginning of this year.
It’s not exactly an exciting product, and that’s just fine with 401k advisors and plan sponsors heavily engaged in the low-fee fight. Throw fiduciary regulation and litigation into the mix and it’s easy to understand their current appeal.
“In today’s highly competitive marketplace, defined contribution plan mandates can be won or lost by the difference of a few basis points,” Jesscia Sclafani, Director, Retirement at Cerulli, said upon the release of a report last fall dedicated to the topic titled, “U.S. Defined Contribution Distribution 2017: Re-Evaluating the Use of CITs in DC Plans.”
Together, mutual funds and CITS hold close to three-quarters of 401k plan assets, making them the most widely used investment vehicles for 401k plans, according to the report.
“Mutual funds consistently represent greater than half of total 401k plan assets,” she added. “The next-largest investment vehicle by 401k plan assets is CITs, which hold almost one-fifth of total 401k plan assets.”
Stealing mutual fund market share would therefore appear a logical next step—which is indeed already happening.
In a survey of 401k plan sponsors nearly one in five indicated that they anticipate switching “the vehicle of at least one investment option” from a mutual fund to a CIT, according to Sclafani.
On its face, 20 percent might not seem like a lot, but considering mutual funds’ DC dominance for decades, it’s significant, and has many asset managers describing 2017 as a collective trust “tipping point.”
And anticipated utilization among 401k advisors is even higher.
Manning & Napier reports that 60 percent of those it recently surveyed expect more of their plans to offer CITs in the next five years.
“[Fully] 83 percent of employers are concerned about the current increase in litigation pertaining to investment selection and fee reasonableness,” said Shelby George, Senior Vice President, Advisor Services at Manning & Napier.
She noted that CITs are an increasingly important part of (what else?) the fiduciary due diligence process.
“While it has always been important for fiduciaries to consider CITs because of the many benefits they provide to participants, today’s 401k fee litigation is making itessential for fiduciaries to give CITs a hard look.”
However, in a frustrating turn, interest and utilization, at least currently, seem to be coming from a select few.
Manning & Napier noted that more than a quarter of advisors surveyed have never used CITs, 35 percent of advisors are not comfortable discussing CITs and 40 percent of advisors feel advisor education on CITs would improve adoption.
Additionally, 47 percent of advisors feel plan sponsors don’t understand CITs, while 83 percent of plan sponsors are not asking for more information on CITs.
Christopher Giles, Senior Managing Partner with GRP Advisor Alliance, agreed.
“I would suggest the vast majority of retirement plan advisors are aware of CITs and their fundamentals,” Giles said. “That being said, a small percentage of retirement plan advisors—taking into account the entire population—have not implemented a CIT with a plan sponsor. They know how they work conceptually and the documents involved, but they’ve never actually recommended one because they traditionally required $750 million and up in assets.”
The larger the advisor, those historically “having played” with plans with more than $1 billion in assets, have the greatest likelihood of having both experience with CITs and having implemented them in the past, Giles added.
Citing his own research, he argued there are only 535 plans in existence with assets that high, so the vast majority of advisors lack a degree of CIT savvy.
However, due to scale largely gained through advisor aggregation firms like GRP, they’re heading decidedly down-market.
“Operationally, a CIT is very similar to a stable value fund, only the investment inside (meaning the CIT) is much simpler. Therefore, the sale is in many ways similar as well.”
So why should advisors look to CITs, and specifically why now?
Steve Glasgow, Senior Vice President with Nashville-based Avondale Partners, pointed to two elements, the biggest one being the aforementioned “fee thing.”
“Obviously, there is some flexibility with the CIT,” Glasgow explained. “If you are negotiating an investment management agreement directly as a large plan sponsor, you can have a little more control over what goes on in there, and that’s all great. But I think it’s really the fees that drive the whole conversation. If you’re in a mutual fund format, obviously, it’s a one-fee-fits-all, and those fees tend to be higher. Not in every case, but in a lot of cases.”
CITs, due to compliance and some other associated issues, “tend to be a good bit lower” in expense, he added.
Given how much focus there has been on expenses in 401k business recently and the fact that, “we are all racing to zero as fast as we can, CITs are a natural way to continue to carve down expenses whenever they are not necessary.”
The main difference between a CIT and a mutual fund is that the CIT involves a direct relationship between the sponsor and the manager of the fund, he continued. The plan sponsor must sign an investment management agreement, as opposed to buying a registered product like a mutual fund where they simply accept the terms of the prospectus.
Like GRP’s Giles, Glasgow noted that CITs have come down-market in recent years—good news for advisors looking to access the product—and that in certain areas they’re mirroring their registered investment counterparts.
“It used to be that you would go to a manager and say, ‘Well, you run this fund, and I would like that same investment option in a CIT format. We are going to negotiate a fee between you and me and it’s going to be something less than what the mutual fund is charging because you don’t have all these regulatory requirements that you have with the mutual fund,’ although you have some obviously, since there is still oversight.”
Also referencing aggregators, Glasgow added that many have negotiated standard, level fee structures on various investment products that allow cost savings to be passed to the end consumer.
“So, you have a CIT that might actually have a CUSIP number, which is much like a mutual fund, and that CUSIP number says, ‘Okay, if you get this CIT, what you’re getting is this portfolio in a bank trust wrapper as opposed to a mutual fund wrapper. The fees on that are X, Y or Z. In some cases, you’ll get some different flavors, with maybe some that allow securities and others that don’t. If you have enough size and scale, all that can be negotiated directly.”
It all sounds so great—essentially the same product with lower fees and therefore potentially better performance. So why, if the necessary CIT size and scale is achieved, go with a mutual fund at all?
Transparency for one, although it’s something Glasgow then immediately dismissed.
“You hear arguments about being able to see them as registered products with ticker symbols. I find that to be, in today’s day and age, pretty irrelevant. Most of your participants access data via the Internet in one way or another, and so the CIT doesn’t have the necessity of that ticker symbol per se.”
There are instances where the mutual funds are less expensive than CITs, he noted, usually when a mutual fund has a large number of assets, whereas the CIT doesn’t, “but you have to look at each case by case.”
Coming full circle, he concluded with the substantial CIT growth to come.
“The regulatory hurdles of having a mutual fund are still high enough that, if there is enough scale in the CIT in general, it’s going to be a less expensive way to access the same investment product. It’s not always the case, but in general.”
GRP’s Christopher Giles lists important industry challenges for the 401k space, which he claims CITs address. They include:
- Advisors should bring innovative ideas, programs and investments to their clients
- Employees, regardless of employer plan size, should be treated equitably
- Plan design and lineups are continually changing
- Advisors may need to streamline processes So how do advisors innovate in light of these challenges?
Giles added the following:
- Be innovative advisors!
- Look toward the future and changing dynamics of the largest plans
- Aggregate purchasing power (our industry’s version of 1,000 lbs. of seeds)
- Identify and forge strategic partnerships and share a common goal
- Create simple processes and messaging