The rise of CITs in the retirement plan advisor market has largely been a function of lower fees. However, while lower costs can benefit participants, advisors and plan sponsors should understand how a CIT strategy is run in comparison to the mutual fund it may replace. Many plan sponsors—especially those overseeing smaller plans—still do not understand the key differences or know what questions to ask, such as, “Do 401(k) plans have to use the lowest cost CIT?” We believe the answer is generally “no,” but that doesn’t mean collective investment trusts can be ignored.
Below we explore what retirement advisors should understand about CITs.
CITs Have Become Mainstream
Once reserved primarily for large retirement plans, CITs became widely accessible after the launch of multi-manager target-date CITs in 2015. Since then, recordkeepers, advisory firms and asset managers have rapidly expanded their offerings. CIT adoption could grow even further if pending legislation that allows 403(b) plans to invest in them passes, significantly expanding the potential market.
Lower Cost Doesn't Automatically Mean a Better Product
ERISA has never required fiduciaries to choose the lowest-cost investment. While cost is an important consideration, prudence still requires evaluating value, structure, performance and participant outcomes.
Industry leaders generally agree that retaining a higher-cost mutual fund can be appropriate in some cases. Still, given the growing availability of lower-cost CITs, committees should not ignore CITs or exclude them without proper and complete evaluation, including whether the strategies are run consistently by the same investment teams.
Even at a lower cost, initial adoption of a new CIT can be a challenge, as Michelle Rappa, Client Advisor—Retirement at Neuberger observes. “For newly launched CITs, some plans are afraid to be the first to adopt the new vehicle, even if it is run the same as an existing mutual fund strategy.” However, “once it is up and running, that issue typically disappears quickly.”
A CIT Is Not Just a Lower-Cost Mutual Fund
Even when a CIT follows the same investment strategy as a mutual fund, it is a distinct legal entity. Unlike moving from one mutual fund share class to another, a CIT only allows investment of certain types of investors, such as ERISA pension plans, so it may have different cash flows, trading patterns, underlying holdings and performance from its mutual fund counterpart, which is open to a broader set of investor types, including some who may trade more frequently than a retirement plan would.
Performance reporting is generally very similar to mutual funds, but pricing is often negotiated for CITs, unlike mutual fund share-class pricing, which is fixed for all investors in a class regardless of investment size.
CITs Are Subject to a Different Regulator
Some advisors and plan sponsors may think that, since CITs are not regulated by the SEC like mutual funds, they are unregulated. In fact, CITs operate under a different but also rigorous regulatory framework: They must be maintained by a bank or trust company and are overseen by either a federal or state regulator.
What Should an Investment Committee Consider?
Retirement advisors should encourage their plan fiduciaries to:
- Evaluate available CIT alternatives to their existing mutual funds
- Determine whether a proposed CIT is comparable to the mutual fund it would replace
- Understand and document the pricing differences
- Update the investment policy statement to address how CITs are evaluated
- Document the rationale behind every decision, regardless of whether the committee chooses a CIT or a mutual fund
Bottom Line
CITs have become an important part of the retirement plan marketplace, and fiduciaries would do well not to ignore them. However, the ERISA obligation remains the same: Conduct a prudent process, evaluate whether a CIT is comparable to its mutual fund counterpart, understand pricing and document why the committee believes its decision is in participants' best interest.
