At the 2020 InvestmentNews RPA Convergence CIO Roundtable and Think Tank, Jamie Battmer, chief investment officer for Resources Investment Advisors, said collective investment trusts were gaining so much momentum that “40 Act funds [in 401(k) plans] are going the way of checkbooks.”
There are many compelling reasons for this rather swift transformation in the retail 401(k) market, which consists of plans with less than $250 million in assets. There are also still many questions about collective investment trusts, or CITs, but none of them seem to be show killers and all of them are being addressed.
Ultimately, the end user of investments cares more about the underlying investment strategy than the wrapper. That wrapper can take the form of separately managed accounts, CITs, mutual funds and annuities, which are listed in order by the size of the market that uses them, from institutional plans down to the micro market.
CITs had been relegated to plans over $250 million or strategies with at least $50 million and closer to $100 million, because their cost limited their availability to smaller plans. But when larger retirement plan adviser groups like NFP created custom CITs for their client base, aggregating the assets of potentially all their plan sponsor clients, even the micro plans could access these funds, enjoying institutional pricing and lower overall costs.
It’s all about pooling assets, which is at the heart of the value of defined-contribution plans, along with the tax advantage.
Not only do custom CITs provide a competitive advantage to RPAs that have access, but plan sponsors arguably could face lawsuits if they do not use them, just as larger plans are being sued because they did not use available lower-cost share classes.
But there are issues and potential conflicts of interest with CITs.
Not all CITs have ticker symbols, although Rob Barnett, head of retirement distribution at Wilmington Trust, the dominant provider of CITs for retail DC plans, says 80% of his company’s funds have a ticker and 100% are expected to have one in 2021. Data companies like Morningstar don’t cover all CITs but one source notes that the issue may be more about the fees Morningstar charges than the availability of the data.
DC plans usually require that funds have a three-year history to be considered, so CITs adopt the performance of their underlying mutual fund. Yet there are tracking errors and discrepancies between the mutual fund and its sibling CIT because of the time an investment has been in the fund. And mutual funds will pay back money they earned from securities lending, while CITs generally do not.
CITs have been around since before the advent of mutual funds and are regulated by the Office of the Comptroller of the Currency rather than the Securities and Exchange Commission. That’s part of the reason CITs are cheaper, but it causes concern for some.
At the CIO Roundtable, some participants wondered whether the SEC will weigh in on CITs and hold the trustee to be more accountable. In reality, trustees like Wilmington Trust are more passive and are unlikely to hire or fire the underlying money manager, just as 3(16) record keepers are unlikely to fire the retirement plan adviser who recommended them, never mind themselves.
You cannot be too stiff to do yoga, but you can be too flexible and go so far that you hurt yourself. CITs may be too flexible, with prices for actively managed investments that are 30% to 50% lower than their mutual fund counterpart beyond the discount of five to 10 basis points. And if one RPA group gets special pricing because of its size, all the other groups ask for the same deal.
Attendees at the CIO meeting were concerned that the race to zero could hurt service. But Barnett said, “The good ones will survive.”
Then there are potential conflicts of interest. CITs are another way for RPAs to generate revenue acting as the 3(38) fiduciary. Have they violated their fiduciary duty by financially benefiting from an investment they recommend above and beyond their plan-level advisory fee? (The same issue may be true for managed accounts but that’s a different story.) Some aggregators have created a separate firm to act as the 3(38), but it might be up to regulators or litigators to determine whether there is enough separation to be meaningful.
The bottom line is that RPAs that don’t have access to lower-price CITs or worse, are not recommending them, are at a steep disadvantage and are potentially exposing clients to liability for not choosing a more inexpensive option. They may end up writing a check to a regulator or law firm, assuming, of course, that checkbooks still exist.
Fred Barstein is founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews’ RPA Convergence newsletter.
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