Collective investment trusts might be he scrawny younger sibling to brawny older mutual funds, but they’re coming on strong. So-called CIT use is being driven by greater plan sponsor and record-keeper acceptance, as well as a greater awareness of low-fee alternatives by the general public.
Indeed, Reuters reports fund companies have shifted billions of dollars from their popular active products into collective trusts in order to compete with lower-cost passive competitors.
Only available in qualified retirement plans, plan participants sacrifice some transparency, but lower CIT reporting requirements help fuel the aforementioned lower costs. Boston-based research firm Cerulli Associates notes that they account for $2.4 trillion, or 16%, of the $15 trillion in 401(k) and pension marketplace, up from $1.3 trillion in 2009.
So why CITs, and why now?
“One benefit is that they are structured to be lower-cost than a traditional mutual fund, but a second benefit is that CITs come with some level of fiduciary protection,” says Randy Swan, president and portfolio manager of the Swan Defined Risk Strategy, which recently became available in the 401k market when the Swan Defined Risk CIT was introduced last month. “Whether it’s a sub-advisor or, like us, a manager, they have a fiduciary duty to the underlying investors, that’s something that mutual funds do not offer. There’s more protection from being held to a higher standard of what we can do and can’t do.”
Swan started his strategy in 1997 as a separately managed account, with a goal of “outperforming the benchmarks over an entire investment cycle, which includes both a bull and a bear market.” The way to do it, he believes, is to have “the right amount of upside and downside capture.”
We note the trite nature of the “win by not losing” or “give up some upside to protect on the downside” cliché, something for which he’s ready.
“Our thesis is that asset allocation and modern portfolio theory work, except when you go through periods of extreme market distress,” Swan argues. “Most of the assets are correlated, so it doesn’t provide the kind of protection you want.”
So what will?
“Our approach is much more direct with modern portfolio theory which is, namely, you buy an option,” he explains. “That option will be inversely correlated with the underlying asset, so it provides a higher level of protection.”
Specifically, Swan invests in ETFs, with 85 percent to 90 percent of the portfolio in something like the S&P 500 (although there are multiple strategies), with the remaining 10 percent to 15 percent in long-term put options.
Comparing it to portfolio insurance, he says the price of the put will act as a deductible.
“You pay a life insurance premium or a health insurance premium and if you don’t have a loss you obviously lose that money. But if you do have a loss there is usually a deductible associated with it, and you won’t be made complete whole in a down market due to the price of the deductible.”
When asked if the strategy is unique in the CIT space, Swan hedges a bit by saying he doesn’t know for sure, before boldly adding that he’d be “willing to bet a large sum of money that there are not any CITs out there that have options imbedded in their programs to manage market risk.”
Offers of wager aside, the proof is in its performance.
Swan notes that the S&P 500 has experienced four years of negative performance since 2000, for a cumulative loss of more than 80 percent. In those same down years, the Defined Risk Strategy provided a total return of positive 18 percent. The key to its overall success, he again emphasizes, is participating in far more upside than downside, 41.39 percent vs. 18.88 percent since its inception, based on monthly data.
It’s achieved a composite account return of 8.91% on an average annual basis from its inception on July 1, 1997 through June 30, 2015 for its flagship S&P 500 version vs. 6.76 percent for the S&P 500. He also claims DRS has also considerably outperformed the Russell 2000, Russell 1000 Value, Russell 1000 Growth and Wilshire 5000 Indices as well.