But how can plan sponsors be sure CITs are an appropriate investment vehicle for their plan? In the following pages, we provide a short discussion covering the history of CITs, how they differ from other investment vehicles and what steps fiduciaries can take to add them to a DC plan.
CIT Basics
CITs, also known as collective investment funds, collective trust funds, common trust funds or common funds, are tax-exempt, pooled investment vehicles maintained by a bank or trust company (the “trustee”) exclusively for qualified retirement plans that are exempt from federal income tax, including 401(k) plans, defined benefit plans, Taft-Hartley plans and certain government plans. Like mutual funds, they comprise an investment portfolio managed by a professional with a defined objective. Unlike mutual funds, a host of regulatory rules limit the eligibility of CIT investors. The table below is a general illustration of the types of investors a CIT may be expected to permit, and those which it may not.
Permitted Investors
- Qualified 401(k) Plans
- Qualified Profit Sharing Plans
- Qualified Stock Bonus Plans
- Certain Taft-Hartley Plans
- Qualified Pension Plans
- Certain Government Plans*
- Certain Master Trusts of Qualified or Governmental Plans
- Certain Insurance Separate Accounts
Ineligible Investors
- Health and Welfare Plans (VEBAs)
- IRAs**
- Certain Section 403(b) Plans
- Non-Qualified Deferred Compensation Plans
- Individual Investors
- Foundations
- Endowments
*Those that are within the meaning of IRC Section 414(d) or an eligible governmental plan trust or custodial account under IRC Section 457(b) that is exempt under IRC Section 457(g).
**Usually ineligible due to securities law reasons.
CIT Regulation
Because CITs hold qualified retirement plan assets, they are generally required to comply with applicable provisions of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The Trustee is subject to supervision and regulation by the Office of the Comptroller of the Currency for national banks or state banking authorities for state banks and the Department of Labor (DOL). As such, a CIT trustee is held to ERISA fiduciary standards for the ERISA plan assets invested in CITs. However, due to exemptions from the registration requirements of the federal securities laws, CITs are not typically registered with the Securities and Exchange Commission (SEC) or any state securities commission, unlike mutual funds.
Growth of CITs
CITs were first introduced in 1927. Early versions of CITs required investor purchases and withdrawals to be processed manually and were valued infrequently, typically only once per calendar quarter, providing investors little access to portfolio and performance data. For this reason, the early adopters of CITs were defined benefit plans.
But starting in 2000, CITs began operating in ways that many believed were more comparable to mutual funds, providing daily valuation and standardized transaction processing, which greatly increased adoption by defined contribution plans. Then, in 2006, the Pension Protection Act provided for a new default investment election for unallocated 401(k) participant assets. These Qualified Default Investment Alternatives (QDIAs) include certain types of “approved” investment strategies and may take the form of managed accounts, target risk funds and target date funds. Many target date funds—the most widely adopted QDIA—are implemented as CITs, and as their assets have grown, so have the assets of CITs generally. Recently, CIT coverage by database vendors such as Morningstar has increased as well, providing additional transparency and reporting capabilities.
CITs have become a popular alternative to mutual funds within qualified retirement plans. Since 2012, CIT use has grown by 56% within DC plans, while the usage of mutual funds has decreased1—a trend that we expect to continue.
Percent of DC Plans that Offer CITs within the Fund Lineup
Source: Callan 2017 and 2019 DC Trends surveys. Multiple responses were allowed.
Increased Usage of CITs due to:
Flexibility
- Ability to use in combination with other investment vehicles like mutual funds and separate accounts in one plan, or even within one asset allocation vehicle (like white label funds or target date funds)
- Fees and investment minimums may be negotiable
- May be used across multiple plans within one organization, such as a defined benefit plan and a defined contribution plan, where judged suitable for each plan, thereby potentially reducing the burden of a plan fiduciary’s governance process
Increased Transparency and Reporting
- Daily valuation
- Standardized and automated daily processing
- Factsheets and enhanced data reporting
- Increased coverage by Morningstar and eVestment
- Standardized strategy, risk, performance and expense disclosures
- Limited revenue sharing
Increased Investment Choices
Originally, CITs were a vehicle used predominantly to deliver stable value or passive strategies. Today, CITs are broadly available across asset classes and investment disciplines, including equities, fixed income, alternatives, multi-asset strategies and international and domestic orientations. They can be actively or passively managed, and can be—and often are—used in a fund of funds structure, like target date or target risk funds.
Suitability
Because of the variety of investment vehicles that now exist for retirement plans, including mutual funds, CITs and institutional separate accounts (ISAs), it is both more difficult and more important than ever for plan fiduciaries to understand the various vehicles and make informed choices. Plan fiduciaries must evaluate many factors to determine which options will serve the needs of the plan participants and their beneficiaries.
Examples of Considerations for Suitability
Investment Strategy: Naturally, one point of evaluation should be regarding the strategy itself: whether it has an attractive track record, sound process, experienced manager, etc. From there, the plan sponsor can evaluate the vehicle through which the strategy is delivered: mutual fund, CIT or an ISA.
Cost: An important factor is evaluating the cost of each investment vehicle.
Size of Plan: The size of the plan can be an important consideration and even a limiting factor: Mutual funds are often better able to accommodate the needs of smaller plans that don’t have the plan assets needed to hit the required investment minimums for CITs (often $10 million, but will vary). By contrast, very large plans may have the scale and interest to seek the customization of an ISA if fiduciaries deem that appropriate for their plan’s needs. CITs probably fit somewhere in the middle, but can be used by mid, large and mega plans.
Additional Considerations: Also, plan fiduciaries should carefully consider the provider’s available investment universe, the plan’s own investment policy statement (IPS), trading and operational considerations, market trends, the demographic makeup of the plan’s participants and the current regulatory environment. Further considerations are shown in the accompanying table.
How do CITs Compare?
Selected considerations when evaluating vehicles for a DC plan.
| Characteristics | Mutual Fund | Collective Investment Trust | Institutional Separate Account |
|---|---|---|---|
| Eligibility | All Eligible Investors | Qualified Plans Only | Single Investor |
| Regulators | SEC | OCC, DOL | DOL, SEC |
| ERISA Fiduciary Standards2 | No | Yes (CIT trustee)3 | Yes4 |
| Ownership | Plan owns shares in the fund—not the fund’s underlying securities | Plan owns units in the fund—not the fund’s underlying securities | Plan owns underlying securities |
| Valuation | Daily | Daily | Daily |
| National Securities Clearing Corporation (NSCC) Traded | Yes | Yes | No |
| Liquidity | Daily | Daily for defined contribution participants | Daily |
| Governing Documents | Prospectus and additional documents | Declaration of Trust and other documentation provided by sponsor | Custom Agreement |
| Fees | Not negotiable; share class management fee is defined | May be negotiable; l/c be scaled | May be negotiable; l/c be scaled |
| Pooled Vehicle | Yes | Yes | No |
| Portability to IRA | Sometimes5 | No | Sometimes |
| Ticker | Yes | No | No |
| CUSIP | Yes | Yes | No |
| Reporting | Extensive public performance information available | Performance available through recordkeeper, by trustee/manager and some CITs are reported on by Morningstar | Performance available through recordkeeper and plan sponsor |
Are CITs Right for Your Plan?
Only your plan’s fiduciaries, in consultation with legal, investment and other advisers, can decide what investment strategy or investment vehicle may be suitable for the plan’s participants. Many of the questions in assessing a CIT are the same questions one would entertain for any investment vehicle or strategy. Some examples are listed below:
- Is the plan’s current investment universe appropriate and comprehensive?
- Does the plan have sufficient investible assets for investment in the vehicle? Are there securities law, tax, ERISA or other restrictions?
- Is the cost structure appropriate given the plan size, services provided and the scope of desired investment options?
- What type of data and/or reporting will be supplied to the plan? Will this reporting be sufficient for participant needs?
- Are there any liquidity boundaries, trading issues or operational considerations?
- Is the investment vehicle the best fit for the plan participants?
Implementation
Once a decision has been made to include a CIT in a plan’s investment lineup, various practical steps will follow. The plan sponsor, along with his/her advisor or consultant, will work with the bank or trust company that serves as trustee to review documents, including a declaration of trust and fund declaration. Plan sponsors will then enter into an agreement, often called a “participation agreement,” with the institution offering the CIT, and will provide documents that validate the plan’s qualified status. The plan’s recordkeeper will also need to execute certain documents with the trust company.
Final Thoughts
CITs are growing in popularity and may be of interest to certain qualified plans. However, when evaluating whether an investment is truly in the best interest of your plan participants and their beneficiaries, be sure to consider all the facts and consult your independent professionals, including investment and legal professionals.
