A Low-Cost Investment Option for Some 401(k) Savers

Question: My employer offers collective investment trusts as part of our 401(k) plan, but I don't understand if these are mutual funds or what. Can you explain?

Answer: Collective investment trusts, or CITs, are similar in many ways to mutual funds, and in some cases are even operated by mutual fund companies. But there are some important differences that you should be aware of before investing in them.

Like mutual funds, CITs are pooled investment vehicles that use a specific strategy to invest. However, while many mutual funds are open to the public, CITs are designed specifically for institutional investors, namely 401(k) and pension plans, and may be customized to meet the needs of that plan. A CIT's portfolio typically is run by an investment manager who may also be a mutual fund manager, and many CITs track indexes, just as index funds do. CIT assets may be invested in stocks, bonds, mutual funds, ETFs, or even real estate and private equity. Some CITs are clones of publicly available mutual funds--with the same manager using the same strategy and with a similar portfolio.

CITs may appear alongside mutual funds on your 401(k) plan investment lineup and may include the abbreviation CIT (or, alternatively, CF or CT for commingled fund or collective trust) in the name. Some plans give CITs generic names such as "U.S. Small-Cap Equity Fund" or "Balanced Fund." Many 401(k) plans offer a low-risk savings vehicle called a stable-value fund, which is, in fact, a CIT.

Not Subject to SEC Regulations
Among the most important distinctions between CITs and mutual funds is that the former is not subject to the Investment Company Act of 1940, which established many of the regulations governing mutual funds, including extensive disclosure requirements. While mutual funds must be registered with the Securities and Exchange Commission, CITs do not have to be. In fact, while mutual funds technically are considered investment companies, CITs are considered commingled accounts and are offered through banks or trust companies. As such, they are regulated by the Office of the Comptroller of the Currency. Like mutual funds, CIT assets are not insured by the Federal Deposit Insurance Corporation, or FDIC, which insures bank savings accounts, for example.

Because CITs are not subject to the more extensive regulations required of mutual funds, their administrative expenses are generally lower. Add to that the fact that they do not need to spend money marketing themselves to individual investors and the cost of running a CIT can be quite a bit less than it is for a comparable mutual fund. These lower costs are passed on to CIT investors, providing them with a cheaper way to invest, and in today's increasingly cost-conscious investing climate, cheaper has become a strong selling point.

Lower Cost, Legal Changes Lead to Surge in Interest
As Christine Benz, Morningstar's director of personal finance, points out in this article, CITs are often cheaper than comparable mutual funds. For example, among all large-blend mutual fund share classes, the median expense ratio is 1.06%; for just institutional share classes, it's 0.75%. But among CIT large-blend share classes tracked by Morningstar, the median expense ratio is 0.60%. The fact that index-based strategies (which are cheaper to execute than those based on actively picking securities) tend to be more common among CITs than among conventional mutual funds adds to their cost advantage. 

Morningstar currently tracks 1,680 unique CITs representing nearly 3,300 share classes. About one third of those share classes are of the target-date variety. At the end of 2012, there were 2,150 CIT share classes, meaning the number has grown more than 50% in just under two years. 

Aside from their low costs relative to traditional mutual funds, another reason for the growing interest in CITs involves the Pension Protection Act of 2006, which allowed companies to use CITs as default investment choices for employees in their retirement plans.

Lack of Transparency May Be an Issue
In some retirement plans, a CIT may be the only investment option of its type on the menu. But how can you tell if it's a good investment option for you? Here's where using CITs to save for retirement can get tricky. Because they are not subject to the same disclosure requirements as conventional mutual funds, information on your CIT may be more difficult to come by. At a minimum, your plan should make available quarterly performance data for the CIT, but more frequent performance data as well as information on the CIT's holdings may be not be available. Some plans offering CITs do provide daily price information on their websites; but if yours doesn't and you need the information--to rebalance your portfolio or take a distribution, for instance--this could complicate matters for you.

Price and performance information for CITs typically is not available on major financial websites, including Morningstar.com. However, if the CIT is a close cousin to a publicly available mutual fund--meaning it's run by the same company with the same manager and a similar portfolio-you might look at the publicly available fund's price and performance history for guidance. Keep in mind, though, that performance is unlikely to match exactly due to fees and other differences.

Stewardship could also be an issue with CITs, at least in theory. As Benz points out in her article, unlike mutual funds, CITs are not required to have boards of directors who look after investors' interests. That doesn't mean 401(k) investors are completely left in the dark, however, as plans themselves are required to serve as fiduciaries--that is, to act in participants' interests--under ERISA (the Employee Retirement Income Security Act).

Because of CITs' low disclosure requirements, 401(k) investors would be wise to carefully read the Summary Plan Description--the document that plans are required to make available to participants describing how the plan works--along with any documentation that pertains specifically to the CIT. You should be able to find information about who manages the CIT, how much it charges, its strategy and holdings, and its performance. If you can't find this information, or it is not sufficiently detailed, ask your human resources department or the plan administrator to provide you with whatever is missing.

Trusting that a CIT is a good investment simply by virtue of its inclusion in your plan is not sufficient. Do your homework. And if the CIT is not run by a well-qualified manager and/or historical performance data is not available, you may want to consider owning a different fund on the 401(k) menu, or investing the money outside of the plan if it offers no suitable alternative.

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