AS TIME RUNS OUT FOR BABY BOOMERS TO BEEF UP their retirement savings, portfolio manager Daniel Oldroyd sees collective investment trusts gaining traction among defined contribution plans. Besides offering uncorrelated, actively managed assets — everything from equities to real estate to commodities — these custom solutions can have lower fees than mutual funds. “A trend among defined contribution plans is increased use of alternative and extended asset classes for diversification to help participants get better portfolio outcomes,” says Oldroyd, a New York–based executive director with J.P. Morgan Asset Management’s global multiasset group. “We can more easily accomplish that with collective investment trusts.” JPAM started offering CITs with its first target date plans, in 2005; today they account for half of the $15 billion in the firm’s SmartRetirement funds. “The investment flexibility is greater,” Oldroyd notes, citing direct real estate investments versus real estate investment trusts, an option not open to mutual funds.
Still marketed only to qualified retirement plans, CITs also offer a flexible expense structure. Despite tough new Department of Labor fee disclosure guidelines that take effect next month, advisers expect these traditionally opaque funds to keep most of their operating cost advantage over mutual funds.
Pressure from plan participants who think sponsors can do better than just buying a retail product is helping drive pension plans to CITs, explains David Hand, CEO of Houston-based Hand Benefits & Trust Co., a division of Benefit Plans Administrative Services of Utica, New York, that provides CIT valuation services. “Large plans, like defined benefit plans, negotiate directly with managers, who place the funds in other investments, including CITs.” Initial investment minimums, once as high as $100 million, are another draw. In 2007, JPAM lowered the minimum for plans wanting to invest in its target-date-style funds, which use CITs, from $50 million in assets to $25 million.
CITs, which have been around since the late 1920s, are invested by bank trustees and trust companies, and overseen by banking regulators such as the Office of the Comptroller of the Currency. Unlike mutual funds, CITs are exempt from Securities and Exchange Commission regulations on disclosure, but both vehicles must comply with Department of Labor and ERISA rules. As for CITs’ share of the defined contribution market, there’s no definitive picture. Of the $4.8 trillion in U.S. defined-contribution-plan assets at the end of 2011, $2.3 trillion was invested in mutual funds, compared with some $2 trillion in CITs, according to Phillip Chiricotti, president of the Center for Due Diligence, a data research firm in Western Springs, Illinois. Chiricotti, who wants to see standardized reporting for CITs, predicts “significant growth” in their use by defined contribution plans as custom solutions become more popular.
In many cases CITs may offer better pricing than mutual funds, says Steven Rabitz, a partner in the employee benefits and executive compensation practice group of New York–based law firm Stroock & Stroock & Lavan. Whereas mutual funds charge retail investors and defined contribution plans the same fees, sponsors can negotiate with CITs. “As assets grow, fees can drop in incremental steps,” says Thomas Applegate, a New York–based client portfolio manager for ING Group, which manages $2.5 billion in CITs.
Under the DoL’s new disclosure rules, CITs that want to be offered as ERISA retirement vehicles must be as transparent as mutual funds, with one exception: If the plan negotiates management fees so they’re embedded in the expense ratio, quarterly disclosure isn’t mandatory. “Some might argue that essentially leaving participants in the dark about financial adviser compensation is contrary to the spirit of Dodd-Frank and DoL goals regarding fee transparency,” says Marcia Wagner, managing partner at Boston-based Wagner Law Group, an ERISA specialist.
Mutual funds can have significantly higher expense ratios than CITs do. The ING Target Solution Trust Series 2055, a $13.45 billion CIT fund that’s 95 percent invested in U.S. equities, estimates its fees at 0.60 percent. By comparison, the $9.46 billion T. Rowe Price New Horizons Fund, a small-cap equity mutual fund, incurs 0.81 percent in fees. And mutual fund expense ratios don’t include the turnover costs for transactions, which can chop a full percentage point off a participant’s earnings, says James Peters Jr., CEO of Birmingham, Michigan–based CIT subadviser Tactical Allocation Group.
As CITs pay more for increased disclosure, could higher fees erode their cost advantage? Providers must eat those expenses or pass them on to investors, JPAM’s Oldroyd says. However, he adds, “very few investment managers really want to raise their fees.” • •
