Thinking of adding a Collective Investment Trust to your company’s 401(k) plan? Learn about their advantages and drawback to help you make the right decision for your company.
The use of collective investment trusts (CITs) is one of the fastest growing trends in the 401(k) industry. While not as widely known as mutual funds, their cost savings potential, tax efficiency, flexibility, and customization make them an attractive choice for plan sponsors.
In the past, CITs were mostly used by large plans due to their high asset minimums. But over the last several years, CITs with lower asset thresholds or no asset minimums have come to market, drawing small and mid-size plans. They now exceed mutual funds as the investment structure most used1 by defined contribution fund managers.
Wondering if CITs are right for your fund? Read on to learn how CITs differ from mutual funds and their potential advantages and drawbacks.
Key Differences Between Mutual Funds and Collective Investment Trusts
A mutual fund is an investment vehicle that pools your money with other investors’ to purchase stocks, bonds, and other securities, based on the mutual fund’s investment strategy.
Mutual funds allow ordinary investors to buy into sophisticated investment strategies with little to no involvement in managing the money. They’re regulated by the Securities and Exchange Commission (SEC) and statutes under the Investment Company Act of 1940. Their governing documents primarily consist of a prospectus and statement of additional information.
Like a mutual fund, a CIT is a tax-exempt, pooled investment vehicle. However, CITs are only available to institutional investors and within employer-sponsored retirement plans like a 401(k). Because CITs don’t deal with retail investors, they’re generally lower cost than mutual funds and are exempt from certain regulatory requirements. CIT providers are regulated by the Office of the Comptroller of Currency (OCC), and the IRS, and Department of Labor. They may be governed by a declaration of trust and investment or operating guidelines.
Potential Advantages to Collective Investment Trusts
CITs have certain benefits not available with mutual funds, including lower fees, tax advantage, and great flexibility and customization. Here’s what to know about each aspect.
Fees: CITs can offer lower fees than mutual funds for several reasons:
- They’re exempt from SEC registration requirements.
- They’re typically not available to the public, which eliminates the need for expensive marketing.
- They have fewer reporting requirements, which reduces the cost associated with frequent reporting and compliance.
- They can have lower trading costs through cross-trading within a manager’s investment strategy.
- Some investments have investment minimums, so CITs can negotiate better pricing and terms with asset managers.
Tax advantages: CITs aren’t required to distribute nearly all their taxable income and gains on an annual basis, so they don’t need to manage the taxation from income gains or losses.
Flexibility and customization: CITs can be customized to meet the specific needs of retirement plan investors, allowing for more flexibility in investment strategies and objectives.
Regulation: While CITs aren’t required to register with the SEC, they’re regulated by the OCC, DOL, and the IRS. They’re also subject to the Employee Retirement Income Security Act (ERISA). Under ERISA, the banks who maintain the collective trusts are required to act as fiduciaries for the management of the assets in the funds.
Potential Drawbacks of Collective Investment Trusts
Now that you’re aware of the advantages, you should know that CITs also come with disadvantages, including accessibility and availability limitations, less transparency and reporting, greater administration needs, and performance differences. Here’s what you need to know about each aspect.
Accessibility and availability: CITs often have higher minimum investment requirements, making them less accessible to smaller investors or smaller retirement plan. Also, they may not be widely available across various recordkeeping providers. If the plan decides to change platforms, investment changes may be required. And consulting and advisory firms may have exclusive pricing or CIT availability based on their relationships with certain fund managers . If the plan decides to move to another advisor, they may no longer be permitted to use the investment.
Transparency and Reporting: CIT information is less broadly available than mutual fund information. While employees can access public information on mutual funds through sources like Morningstar, CITs aren’t required to disclose information like their holdings or strategies as frequently as mutual funds, which can limit transparency for investors.
It’s also difficult to know a CIT manager’s track record. CIT managers often create new share classes for individual consultants or based on asset minimums. These share classes don’t have the lengthy track record of their mutual fund equivalents, and it can be more difficult to provide reporting on the manager’s full performance history.
Administration: Additional paperwork is required by plan sponsors to include the CIT in a plan. Some providers require a power of attorney on the investment or a legal review of the collective trust documents. There may also be additional scrutiny from plan auditors.
Performance Differences: While many CITs use the same investment managers and strategies as their mutual fund counterparts at a lower expense, these investments don’t always outperform on a net of fee basis. There are several factors that can lead to underperformance by the collective trust including:
- Investment universe: Often, a collective trust can’t invest in certain asset classes available to mutual funds, such as pre-IPO securities, direct real estate, commodities, and collateralized loan obligations (CLO) because of investment minimums or CIT restrictions.
- Cash flows: Often, CITs have smaller asset amounts, so they’re more likely to see their performance impacted by the timing of contributions and distributions into and out of the fund.
- Inception date: CITs often have more recent inception dates than mutual funds. This impacts reporting and can also mean that the funds missed out on private placements pre-CIT establishment, which are holdings of the mutual fund. The inception date also significantly impacts bond portfolios that may have purchased long-term securities prior to the inception of the CIT. This makes it very difficult to replicate fixed income mutual fund portfolios within a CIT.
Need help with your 401(k) plan?
Now that you know the advantages and disadvantages of CITs, you can weigh them against your companies short- and long-term goals. If you need help, Sequoia’s advisors can help you craft a 401(k) that best serves your employees and your business needs.
A Sequoia advisor is ready to listen and answer your questions. Connect with an advisor today.
- Natalie Lin. Planadviser (2023, November 10). CITs Surpass Mutual Funds as Preferred Investment Vehicle for DCIOs. https://www.planadviser.com/cits-surpass-mutual-funds-preferred-investment-vehicle-dcios/
Pensionmark Financial Group, LLC (“Pensionmark”) is an investment adviser registered under the Investment Advisers Act of 1940. Pensionmark is affiliated through common ownership with Pensionmark Securities, LLC (member SIPC).
DISCLAIMER: This communication is intended for information purposes only and should not be construed as legal or tax advice. It provides general information and is not intended to encompass all compliance and legal obligations that may be applicable to your situation. This information and any questions as to your specific circumstances should be reviewed with legal counsel and/or a tax professional.
