December 7, 2012 10:53 am

Greater transparency boosts collective trusts

As collective investment trusts win over more sponsors of defined contribution plans, they are gaining ground in a space dominated by mutual funds.

CITs, also known as collective fund trusts, are most prevalent in large and mega DC plans that manage $500m or more in assets. These plans are attracted to the lower costs of the bank-regulated products, but the lack of transparency in CITs has long stymied their traction in the wider DC market.

“They lack the same level of regulatory oversight as mutual funds, so some plan sponsors are not as eager to step outside the box,” says Jason Roberts, chief executive of the Pension Resource Institute.

CITs are not registered with the Securities and Exchange Commission, so they are not required to report redistribution or redemption fees, or to disclose trading restrictions.

But CIT managers are starting to make themselves more transparent and more competitive with mutual fund providers.

Advisers also have played a big role in making their plan sponsors “comfortable” with CITs as a viable alternative to mutual fund-focused DC plans, says Joel Lieb, managing director of SEI’s investment manager services division. Sponsors, for example, better understand the regulatory structure in place for CITs, he says.

CITs and mutual funds “are certainly not regulated the same way, but one thing CITs do have that mutual funds don’t is that they are not exempt” from the Employee Retirement Income Security Act, Mr Lieb says.

“So from a plan perspective, not only do you have the trustee, but you also have the investment adviser for the fund that acts as a [fiduciary] adviser,” he says. “It just adds another level of oversight that the [SEC-regulated] funds do not provide.”

A Celent report on new investment vehicles in the DC market also notes that CIT managers are striving to address transparency and disclosure concerns of plan sponsors and advisers.

“Thanks to improved networks and connectivity, collective investment trusts can now be priced on a daily basis,” the November 2011 report states. “Such changes in transparency and pricing have provided a ‘foot in the door’ effect for CITs in the DC market. Now that CITs offer similar reporting and tracking to mutual funds, their plan sponsors can explore their inherent cost advantages.”

The move towards increased transparency and disclosure has made it easier for plan sponsors and advisers to focus on costs. One cost savings benefit is the reduced marketing expense for CITs as they target 401(k) and other qualified retirement plans.

They attract “financially savvy investors who actually go and ask for the CIT”, says Jeremy Stempien, director of investments for Morningstar’s investment management division.

Mutual funds have responded by scaling down what was once a 20 basis point cost differential a few years back to 10bp, says Mr Stempien. Vanguard offers among the lowest average expense ratio of 20bp for its mutual funds, which is actually cheaper than the average CIT management fee of 56bp, as calculated by Morningstar.

But Matt McCarthy, principal and head of institutional sales at Vanguard, acknowledges that the average mutual fund expense ratio is about 112bp (according to Lipper).

Vanguard aside, CITs overall do better at containing costs than mutual funds, says Mr Stempien. They also have the ability to negotiate fees upfront where mutual funds offer set break points, he says.

Omar Aguilar, senior vice-president at Charles Schwab Investment Management, says the firm works with plans as low as $25m, and that 40 per cent of the plan sponsors in its target-date CITs hold less than $500m.

“The trend is that assets in collectives continue to grow, but the percentage coming from mega-plans is probably less,” he says.

As of mid-year, DC assets equalled $4.7tn and accounted for 25 per cent of all retirement plan assets, according to Alexander Camargo, analyst at Celent. The research firm projects that the DC market will hold about 29 to 34 per cent of assets in CITs in 2015, only second to mutual funds as the most favoured DC investment vehicle.

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