More 401(k) Plan Sponsors Considering Collective Trusts

By Patty Kujawa

May. 7, 2009

Move over, mutual funds. The number of collective investment trusts available to institutional investors is exploding, and the trusts are offering many 401(k) plan sponsors a less expensive way to provide competitive investment options to employees.

“Every penny matters now,” says Pamela Hess, director of retirement research for Hewitt Associates in Lincolnshire, Illinois. “There are a lot of great ways collective trusts can be used to help employees and manage fees.”

Chicago-based Morningstar reported 400 new collective trusts created between September 2007 and September 2008. In total, Morningstar tracks 1,000 collective trusts with $2.69 trillion under management.

For years, mutual funds have been more popular among 401(k) plan sponsors because of timely valuations, myriad investment strategies and, to some extent, name recognition with participants. Collective trusts remained on the back burner mainly because of regulatory and transparency issues. But these concerns are being outweighed by many plan sponsors’ need to lower investment fees and other plan costs, experts say.

“There is pressure to reduce fees that plan participants pay,” says Phil Masterson, managing director for SEI’s Investment Manager Services Division. He says collective trust fees can be as low as .25 percent. “Fees impact returns,” Masterson notes.

A May 2008 white paper by the Oaks, Pennsylvania-based investment company shows a collective trust’s average fee is 26 basis points lower than a comparable large-cap equity mutual fund. For example, $10,000 invested in a Standard & Poor’s index fund 30 years ago would yield $335,270 today, SEI reports. But the same amount invested in a collective trust during the same time frame would earn $361,563. SEI currently administers 125 collective trusts with $25 billion in assets.

These investments are similar to how mutual funds pool assets from multiple clients into a specific investment account. But collective trusts are only for institutional investors, and are not regulated by the Securities and Exchange Commission. And, only banks, trusts, or money managers that have access to these capabilities can offer the investment.

While collective trusts fall under banking regulations, the lack of SEC oversight translates into fewer reporting, disclosure and other operational requirements that increase many mutual fund costs. Plus, because this investment is exclusively for institutional clients, there aren’t any retail advertising or marketing fees.

“They really have the capacity to get lower fees than mutual funds, and they are simply cleaner,” Hess says. “Being run more institutionally helps keep things more focused. [Collective trusts] aren’t trying to woo retail investors.”

While collective trusts have been popular among large employers including Intel and Time Warner, smaller employers are starting to evaluate how the vehicles can fit into their investment strategies. And because collective trusts have fewer regulatory hurdles and can get to market faster than mutual funds, investment professionals are trying to broaden their menu of options, experts agree.

Hess says she has sees more questions lately from plan sponsors about collective trusts in requests for proposals. Steve Deutsch, Morningstar’s director of separate accounts and collective trusts, says he fields weekly phone calls from money managers who want to enter this market.

In February, San Francisco-based The Online 401(k) introduced five target-date collective trust index funds managed by Hand Benefit & Trust Inc. The Online 401(k) provides Web-based retirement plans for 2,500 small businesses nationwide.

Morningstar data show that nearly 25 percent of the 400 new collective trusts added in the past year are target-date investments.

Chad Parks, president of The Online 401(k), says clients are looking for a “less public” and more sophisticated way to invest funds. Also, clients want options in satisfying the 2006 Pension Protection Act’s requirement for qualified default investment alternatives, as well as its mandate for plan sponsors to find low-cost investment options.

“We are always looking for the best value,” Parks says. “We didn’t want to be exposed to the retail environment.”

Experts say fees are negotiable, and that’s where big savings can happen, especially for larger plan sponsors. Mutual funds have set fees, but depending upon assets under management, collective trusts can adjust pricing structures.

Susan Gallagher, a spokeswoman at Ameren Corp., a St Louis-based utility company, says the company uses four collective trust funds totaling 47 percent of its $1 billion 401(k) plan because they are generally more cost-effective than mutual funds. Nearly 90 percent of the company’s 10,000 employees participate in the plan.

While Ameren is satisfied with its current lineup, Gallagher says the company may increase its collective trust offerings.

But collective trusts aren’t without faults, experts agree. One hurdle is that participants can’t roll collective trust assets into an individual retirement account because they are tailored specifically for clients and aren’t publicly traded. Currently, participants liquidate their collective trust assets and roll cash into IRAs.

SEI’s Masterson says that while this is a sticking point, plan sponsors are focusing more on cost savings, which is a top priority in the current economy.

Historically, collective trusts have been criticized for their lack of transparency. Participants can’t track assets in the newspaper or on public Web sites like their mutual fund investments. And while the absence of SEC disclosure requirements is a good thing in helping the bottom line, it can be hard to get complete information.

But this issue is improving with Morningstar’s tracking information available to institutional investors and their 401(k) participants. Typical data include gross and net performance, portfolio holdings, fee data and manager information.

“We produce fact sheets for CITs that are very similar to our mutual fund fact sheets, and the retirement plan participant could see a clear, concise profile of the CIT,” says Rachael Olson, institutional analyst for Morningstar. “They would receive updates as often as their plan sponsor had paid to receive them, but quarterly is typical.”

And in light of recent investment scandals, some may balk at collective trusts because there is no SEC oversight, Hess says, adding that the investment does fall under federal and state banking regulations. “It is different,” Hess says. “That may be difficult for people to get used to.”

Still, smaller employers may not see savings like organizations with 1,000 or more employees, which have better negotiating power, Hess says. Offering a collective trust may require more administrative costs to a small employer, where a large employer could negotiate a better pricing structure.

“Some companies can’t just flip a switch,” Hess says. “They need to be really thoughtful in evaluating their situation.”

Patty Kujawa is a freelance writer based in Milwaukee.


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