1 Callan, 2021 Defined Contribution Trends Survey.
C O L L E C T I V E
CITs Energize DC Plans with a Flexible, Cost-Efficient, Customizable Option.
I
T’S MORE IMPORTANT THAN EVER FOR PLAN SPONSORS to create the best possible outcomes for retirement plan participants – and that means providing quality investment options at a reasonable cost. Not only is it the right thing to do for plan participants, it’s also a fiduciary duty.As the focus on fees continues across the industry – coupled with a rise in plan fee litigation – forward-thinking plan sponsors increasingly value cost-efficient and flexible investment vehicles that can help with plan management and participant retirement savings success.
We believe the nature of collective investment trusts (CITs) allows them to rise to this challenge. With increasing ease of use, pricing flexibility and the potential to avoid litigation due to offering a lower cost alternative, CITs have gained significant momentum over the past decade.
Rising Use of CITs in DC Plans1
78 %
2020in
44 %
2011in
2
CIT FUNDS CITs seek to take advantage of economies of scale to offer lower overall expenses, enhanced risk management, and more diverse investment opportunities than mutual funds – the most common vehicle used in DC plans – can typically offer. The increasing transparency and reporting over recent years make CITs a more modern and approachable option to plans of all sizes. While
both CITs and mutual funds are pooled vehicles with common attributes, CITs are available only in Employee Retirement Income Security Act (ERISA) qualified retirement plans. CITs help address industry-wide fee pressures as the associated cost savings are passed on to plan sponsors and participants.
In this article, we’ll cover four key CIT
considerations that plan sponsors of all sizes need to know. We will also provide some questions for plan sponsors to consider when determining whether a CIT structure is the right vehicle to use for any investment strategy on the plan’s DC menu.
Source: The Coalition of Collective Investment Trusts, Collective Investment Trusts paper, 2015.
Governance and Regulatory Oversight Unlike mutual funds, CITs – also known as collective funds, commingled funds, common funds and common trust funds – are exempt from SEC regulation and are not subject to the Securities Act of 1933 or the Investment Company Act of 1940. Instead, as bank products, they are regulated at the federal and state level by the Office of the Comptroller of the Currency (OCC). The OCC generally makes fewer regulatory demands than the SEC makes on mutual funds,
including extensive requirements for registration, operations, disclosure and reporting. This
contributes in part to CITs’
lower pricing.
A CIT is established and governed by its Declaration of Trust, which outlines the fund’s terms and conditions (e.g., investor eligibility, valuations, subscriptions and redemptions).
Qualified Plans Only Declaration of Trust
Office of the Comptroller of the Currency (OCC) and State Regulated
Trustees Held to ERISA Fiduciary Standards Data Provided by Manager Institutional Pricing Pricing Flexibility
All Investors Prospectus
U.S. Securities and Exchange Commission (SEC) Registered and Regulated
No ERISA Fiduciary Standards Data Publicly Available Institutional and Retail Pricing No Pricing Flexibility
Pooled Vehicle Daily Valued National Securities Clearing Corporation (NSCC) Traded Fact Sheets Available Audited Annually
MUTUAL FUNDS
How CITs Work
How CITs Work 2
How DC Plans Are Using Modern CITs 5 Key Benefit #1: Enhanced Pricing Flexibility 7 Key Benefit #2: Potential to Avoid Litigation 9 CIT Evaluation Considerations 11
CITs are cost-efficient, tax-exempt investment vehicles. They are professionally managed pools of tax-qualified retirement plan assets maintained by a bank or trust company.
3
WHO CAN INVEST?
Eligible — Qualified Retirement Plans Subject to ERISA
401k plans
Money purchase plans
Pension plans/defined benefit plans Profit sharing plans
457 government plans Taft-Hartley (union) plans
Not Eligible
403(b) plans, 457(b) and 457(f) plans IRAs
Health and welfare benefit plans
Voluntary Employees’ Beneficiary Associations (VEBAs)
Nonqualified deferred compensation plans
Fiduciary Oversight
The CIT trustee (the bank or trust company maintaining the CIT “fund”) is responsible for managing and overseeing the investment of the fund’s assets as a fiduciary and in accordance with ERISA’s fiduciary responsibility provisions:
Potential Broader CIT Usage with Proposed 403(b) Regulation
Most 403(b) plans, which serve as retirement plans for many universities, hospitals and K-12
programs, are not eligible to invest in CITs. The Public Service Retirement Fairness Act, introduced in March 2020, includes provisions that would allow 403(b) plans to invest in CITs, if signed into law.
Operating Structure
Investment Manager
Plan Sponsor
CIT
Custodian CIT
Auditor Transfer
Agent Fund
Accounting Fund Admin Consultant
CIT Trustee 3(38) Fiduciary
Source: DST Kasina, Global Trust Company.
The Plan Sponsor and the Plan’s Advisor or Consultant select and monitor the CIT Trustee and Investment Manager. The Trustee oversees the investment manager and investment operations.
The CIT trustee may engage one or more investment advisors, often referred to as CIT subadvisor(s) to help oversee the trust.
As a 3(38) fiduciary, the CIT trustee accepts a delegation of investment management responsibility from the sponsor of a participating plan.
4
Increased Transparency & Reporting As CITs are regulated differently from mutual funds, they are not required to file their portfolio holdings, issue shareholder reports, or send their net asset values to central databases. In the past, this lack of transparency limited the attractiveness of CITs to DC plan sponsors.
However, significant reporting changes have taken place over the past 20 years. Today’s modern CITs have become increasingly transparent – and therefore more approachable – for both DC plan sponsors and participants.
For plan sponsors:
Today’s public databases, such as Morningstar, generally collect and share granular CIT data including total assets, fees, net expense ratios, performance metrics and net asset value (NAV). A majority of CITs are traded and valued daily. Additional data, such as a CIT’s all-in cost (provided to Morningstar by 78% of CIT providers), can be an important component of a plan investment committee’s due diligence.
For plan participants:
Participants typically have access to fact sheets describing a specific CIT’s investment objective and strategy, policies, fees and expenses, and risk characteristics. Designed to provide similar information to a mutual fund’s fact sheet, this information can help participants make investment decisions and help with a plan sponsor’s fiduciary responsibility to provide investment-related information, including information about fees and expenses, to participant-directed plans.
2 DST Kasina, Collective Investment Trusts, A Perfect Storm, March 2017.
Morningstar currently covers upwards of 95%
of the CITs being offered, with a growing list of additional firms (including eVestment, Callan Associates, Cambridge Advisors, Segal RogersCasey and Zephyr) covering CITs.2
Trustees now commonly create ticker symbols for their CITs allowing them to be tracked on Nasdaq.
Most CIT providers also prepare a fund offering document that further describes, among other things, the fund’s material terms, investment objective and strategy, policies, fees and expenses, and risk characteristics, which can help plans and participants make informed decisions.
2000 CITs began trading on the NSCC Fund/
SERV® platform
Provides similar operational efficiencies as
mutual fund structures (daily value and
daily traded)
2012
Department of Labor (DOL) required all CIT investment providers to standardize risk,
performance and expense disclosures
Increases standardized and automated daily
processing Helps provide data for
participant fund fact sheets and enhanced
data reporting
2019 CITs were
added as listings on
Nasdaq
Allows CITs to have Nasdaq tickers
2020 Nasdaq Fund Network (NFN)
includes CITs on its network
Makes CITs shareable on
market data platforms and financial
web portals Action
Benefit
We believe CIT providers have encouraged these changes and continue to look for increased transparency options for both DC sponsors and participants.
5
How DC Plans Are Using Modern CITs
Sponsors Use Low-Cost CITs Across Custom Strategies, Target Date Funds (TDFs) and White Labeling Efforts.
Historically CITs were used almost exclusively in defined benefit (DB) plans. Now 60% of CIT assets belong to DC plans, eclipsing the 35% used in DB plans.3
3 Cerulli Associates, in partnership with the Coalition of Collective Investment Trusts. Data represents trusteed assets as of year-end 2019. Percentages are asset weighted.
What’s driving CIT adoption in DC plans?
Fee pressure
Increased prevalence
Fiduciary role and obligation
Improved transparency and reporting
CITs’ flexible investment strategies can be used on their own, or in combination with other investment vehicles like mutual funds and separate accounts in one plan. They can be implemented across a range of white label investment strategies or act as an underlying sleeve in TDFs. In most cases, they offer lower costs and the ability to customize the management fees of the fund.
Employers have recognized how cost-effective CITs can be to help reduce investment fees, often the biggest-ticket item in retirement plans.
Source: Callan DC Trends Surveys, 2012-2021. Multiple responses were allowed.
The Rising Use of CITs in DC Plans
Over the past decade, the use of mutual funds has decreased by nearly 10% while CITs have increased by about 25%.
CIT Mutual Fund
100%
80%
60%
40% 2011 2014 2018 2020
95%
88% 83% 85%
44%
60%
75% 78%
By year end 2019, more than one-third (38%) of DC CIT assets were held in domestic equity funds, followed by target date (28%) and developed international equity (12%).3
6
4 Callan, 2020 Defined Contribution Trends Survey.
5 Brightscope, An ISS Marketing Intelligence Business, CITs Cement Lead within Defined Contribution Plans, October 16, 2020.
6 DST Kasina, Collective Investment Trusts, A Perfect Storm, March 2017.
The Increasing Role of CITs in TDFs Since the passage of the Pension Protection Act in 2006 and the creation of qualified default investment alternatives (QDIAs), target date strategies have risen exponentially to become nearly ubiquitous in DC plans. By 2020, 93% of plans offered TDFs with 87% using them as the plan’s default.4 Given their wide usage across plans of all sizes, TDFs also expanded across multiple structures.
According to a recent ISS Marketing Intelligence report,changes in market share between CITs, mutual funds, and separate accounts in TDFs over the past decade show CITs taking a significant lead over both: By the end of 2018, CITs’ TDF market share of 60% was more than 20%
over mutual funds, and more than 55% over separate accounts.5
The CIT wrapper – a more flexible investment structure that may be better suited to longer-term, outcome- based strategies – has enabled ERISA-compliant TDFs to proliferate.
680 70 60 50 40 30 20 10 0
Share of TDF Market (%)
CITs Take the Lead in TDFs
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: BrightScope, An ISS Market Intelligence Business, CITs Cement Lead Within Defined Contribution Plans, October 16, 2020.
CIT Mutual Fund
Separate Account
While CITs have increased TDF market share across both small and large plans, mega plans (those with more than $1 billion in assets) dominate their use, as CITs held 86% of TDF assets, compared with 32% for plans with less than $1 billion.
CIT strategies can help plan sponsors move from one-size-fits-all options to custom TDFs tied to the
28%
4%
60%
38%
2%
68%
unique needs and demographics of the plan. This allows for a customized glidepath tied to either the plan or participants, the inclusion of any asset class (e.g., alternatives or emerging markets), and increased control (if desired) over manager selection or the active/passive mix.
7
7 Plansponsor, “How and Why to Simplify DC Plan Investment Menus,” April 30, 2019.
8 Morningstar, Inc., data on strategies that offer a CIT.
9 Cerulli, U.S. Defined Contribution Distribution 2020.
White Labeling with CITs
White-labeled CITs can help simplify the
investment lineup at a lower cost while enhancing the investing experience for participants. Panel executives from Microsoft and Comerica taking part in the 2019 Plan Sponsor Council of America conference shared how the inclusion of white- labeled CITs into their respective plans (resulting in simplified lineups) increased plan participation significantly. In Microsoft’s case, they credit much of their 93% participation rate (without auto enrollment) to their simple lineup of white- labeled CITs.7
Key Benefit #1: Enhanced Pricing Flexibility
CITs Help Address Industry-Wide Fee Pressures as the Associated Cost Savings are Passed on to Plan Sponsors and Participants.
CITs typically have lower compliance,
administration, marketing and distribution costs than mutual funds, resulting in significant savings.
In fact, across strategies that offer both CITs and comparable mutual funds, CIT costs are lower 82% of the time.8
Beyond the lower costs inherent in the CIT structure, one third (32%) of CIT assets were in a custom fee arrangement, primarily implemented through separate share classes, by the end of 2019.9
While these statistics make it evident that larger plans are best positioned to take advantage of CIT pricing efficiencies based on their plan assets and economies of scale, pricing “breakpoints”
are also available at the share class level, or within a specific share class, offering more favorable pricing for smaller plans at each incremental breakpoint.
The flexibility of CITs also makes it easy for sponsors to pool assets across multiple DC and DB plans for additional cost savings, which can be beneficial to large companies and those with a history of M&A activity. In these instances, the cost savings must be spread proportionately across the plan accounts, according to ERISA regulations.
0.80
0.70
0.60
0.50
0.40
Net Expense Ratio
Vehicle Selection and Size Impact Expenses
0-1 1-50 50-100 100-150 150+
Source: Lazard. For illustrative purposes only. Display shows total expense ratios for an example mutual fund, CIT and separate account in a similar strategy. Each strategy will have its own set of expenses in each investment vehicle and will differ from the example.
R6 Mutual Fund
CIT Separate Account
Asset Size of Investment (USD Millions)
In a fee-conscious environment, CITs have gained attention as a low-cost alternative to mutual funds, even competing with R-6 (“triple-zero”) share classes, and with separate accounts at certain plan sizes.
CITs are lower 82% of the
time when comparing the
least expensive CIT and
mutual fund classes or tiers.
88
CITs’ low-cost structure can also help bring relatively low-cost active management to participants who might normally choose passive strategies due to a perceived lower price.
Access to Affordable Active Management CIT’s are a lower-cost active strategy option.
The Sweet Spot for CITs is Expanding
Lower Higher
Least Greatest
Micro Plans (<$5mm) ETFs and Retail
Mutual Funds
Collective Investment
Trusts
Institutional Separate Accounts Institutional
and R-Share Mutual Funds
Small Plans
(>$5mm - $50mm) Mid-market Plans
($100mm - $1b) Large to Mega Plans (>$1b)
Source: DST Kasina.
Flexibility of Investment Options
Relative Investment Cost
Plan Size (log scale)
A Tax Benefit
As an additional benefit, CITs offer more favorable tax treatment regarding foreign dividend withholding taxes. As underlying CIT investors are tax-exempt ERISA plans, a CIT is able to reclaim a greater share of foreign dividend withholding taxes (DWT) than a mutual fund, which can include taxable investors as well.
0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00
Active Passive
Mutual Fund
CIT Source: Morningstar, Inc. Data as of 30 June 2020.
Average Asset-Weighted Expense Ratio
.65
.08
.37
.05
9
Understandably, plan sponsors are increasingly sensitive to the rise in litigation over plan fees. As CITs are gaining widespread adoption in the DC market, some plan sponsors have come under fire for not considering CIT versions of certain investment options on their plan menu, instead using more expensive retail and/or institutional mutual fund share classes.
Class action litigators are starting to proactively target plan fiduciaries who fail to investigate lower-cost investment vehicle options, like CITs.
Recent lawsuits filed suggest that plan sponsors who fail to prudently consider lower-cost share classes in mutual funds or the lower-cost alternative of a CIT may face litigation.
Key Benefit #2: The Potential to Avoid Litigation as a Lower-Cost Alternative
The Argument for CITs
Company Plan AUM Allegation Nvidia
(September 2020) $1.02 billion
(12/31/2018) Plaintiffs allege plan fiduciaries breached their duties by failing to
“review the plan’s investment portfolio with due care to ensure that each investment option was prudent in terms of cost” and maintaining certain funds despite the availability of identical or similar investment options with lower costs and/or better performance histories.
Specifically, the plaintiffs criticized failing to use the lowest-cost share class for many of the mutual funds within the plan and failing to investigate collective investment trusts as alternatives to mutual funds.
Biogen, Inc.
(Two suits filed, 2020)
$1 billion
(12/31/2019) First suit - July 2020: Plaintiffs allege plan fiduciaries neglected to exercise a prudent process when reviewing investment fees. Plaintiffs claim they failed to utilize the lowest-cost share class for mutual funds or to consider available collective trusts as alternatives to the mutual funds in the plan, despite the CITs’ lower fees.
Second suit - August 2020: Plaintiffs allege plan fiduciaries failed to disclose to participants the expenses and risks associated with the plan’s investment options, allowing participants to be charged
“unreasonable expenses,” and offering investment options that cost more and performed worse than other “more prudent” investment options that “were readily available,” including CITs.
LinkedIn Corp.
(August 2020) $818 million
(12/31/19) Plaintiffs allege plan fiduciaries frequently failed to use the share class with the lowest cost for many mutual funds in the plan, and “failed to consider certain collective trusts available as alternatives to the mutual funds in the plan, despite their lower fees and materially similar investment objectives.”
Teva
Pharmaceuticals USA, Inc.
(December 2019)
$2 billion
(12/31/19) Plaintiffs allege plan fiduciaries should have considered offering CITs instead of mutual funds, saying that the CITs were cheaper than comparable existing mutual fund options. Status: As of November 2020, Teva has agreed to pay $2.6 million to settle claims.
Source: Pensions & Investments, 2020.
CITs can support plan sponsors in their increased focus on fiduciary obligations. The CIT trustee (the trust company or bank maintaining the CIT) will always be a 3(38) fiduciary, which may provide the plan sponsor with additional protection.
10
How CITs Differ from Other Investment Vehicles Feature or
Characteristic Collective
Investment Trusts Mutual Funds Separate Accounts Investment
Vehicle Type Pooled
Held at Bank or Trust Company
Exclusive to certain DC plans – not available to individual investors
Pooled
Held by Asset
Management Company
Not pooled
Held by Asset Management Company
Oversight
and Regulation OCC, Internal Revenue Service and DOL
Fund Trustee subject to ERISA fiduciary standards
SEC and Investment Company Act of 1940 Manager not held to ERISA fiduciary standards
SEC
Manager not held to ERISA fiduciary standards
Governing
Documents Declaration of Trust and OCC
Asset Management Handbook Prospectus and
additional filings Custom
arrangement/investment policy statement
Fees/Fee Components;
Fee Flexibility
Commonly lower compliance, administrative, advertising and marketing costs allow plan- level pricing flexibility and may vary in assessing operating and management expenses
Increased regulatory scrutiny on costs and fees. Higher fees due to compliance, administration, advertising and marketing
Pricing breaks cannot be done at the plan level
There is significant fee flexibility as plans pay a management fee that is negotiated on a client-by- client basis
Setup Costs Less expensive to organize and operate
More expensive to organize and operate
Less expensive to organize and operate
Unique Setup Considerations
Require a keystone client and manager needs to create a trust company or hire trustee services
Trust structure; series trust vs. standalone share class offerings
None
Speed to
Market Fast; Not subject to lengthy registration process required under 40 Act
Portfolio manager has more flexibility to fully implement the strategy
Slow; At least a 90- day SEC review period required
Fastest
Sources: DST/Code of Federal Regulations for Banks and Banking; Coalition for Collective Investment Trusts; Lazard.
11
It’s important to evaluate CITs compared with other investment vehicles and share classes in light of the plan’s size, assets and demographics. As part of the plan’s annual review and investment strategy ongoing due diligence, the following questions are designed to help determine if a CIT is an appropriate investment vehicle for the plan’s investments and its participants:
For each investment strategy on the plan menu, consider:10
CIT Evaluation Considerations
Many of the traits that separate modern CITs from mutual funds are increasingly turning out to be compelling advantages in today’s DC environment:
The modern CIT offers plan level pricing flexibility, an expanded universe of investment objectives and increasing transparency and reporting to meet the needs of DC plans and participants.
While both CITs and mutual funds are pooled vehicles with common attributes, CITs are for qualified retirement plans only, are bank regulated, and offer an expanded universe of investment objectives and pricing flexibility.
In an increasingly fee-focused and litigious DC market, the lower cost and pricing flexibility of CITs – combined with a plan’s due diligence approach to selecting the CIT vehicle – is an appealing option. Since CITs help address industry-wide fee pressures, larger DC plans sponsors are increasingly using CITs across custom strategies, TDFs and white labeling efforts, resulting in cost savings for participants.
Putting It All Together
10 The Coalition of Collective Investment Trusts, 2015.
Is the cost structure appropriate given the plan size, services provided and the scope of desired investment options?
Is there an opportunity to customize fees based on plan needs?
What type of data and/or reporting will be supplied to the plan and its participants?
Are there any liquidity boundaries, trading issues or operational considerations?
How experienced is the asset manager, and what is the firm’s reputation in the marketplace?
Would the plan (and participants) benefit by switching some asset categories to CITs due to cost- or fee-adjusted performance?
12
DC Rising is the Lazard Insights Magazine for the new retirement imperative.
Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change.
This material is for informational purposes only. It is not intended as, and does not constitute, financial advice, fund management services, an offer of financial
products or to enter into any contract or investment agreement in respect of any product offered by Lazard Asset Management and shall not be considered as an offer or solicitation with respect to any product, security, or service in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or unauthorized or otherwise restricted or prohibited.
Important Information
FOR MORE INFORMATION please contact your Retirement Plan Advisor or Consultant, or visit us at www.lazardassetmanagement.com.
April 2021