Wait, What's That in My 401(k)?

If you’re a regular Morningstar.com reader, it’s a good bet you like to do your homework before making a purchase. You check out the latest consumer reviews before buying a new car or a washing machine, investigate hotels’ ratings on Tripadvisor before booking a reservation, and scrupulously research investments before giving them a home in your portfolio.

But if you’re investigating holdings in your company retirement plan, you may have hit upon some unfamiliar-looking options that you can’t readily find information on or include in your portfolio tracking system. Is it a mutual fund, or some other vehicle? Should you stick with the more familiar options, or could you be missing out on something worthwhile?

These questions are increasingly commonplace, as the defined-contribution landscape has changed dramatically in recent years. Many large 401(k) plans are replacing mutual funds with what are called collective investment trusts. And even plans that are using mutual funds rather than CITs may sprinkle in a few unfamiliar, hard-to-research options, such as stable-value funds (often a variety of CIT) or guaranteed investment contracts.

Here’s a look at a few of those vehicles that pop up in defined-contribution plans (like 401(k)s).

Collective Investment Trusts What They Are: Collective investment trusts are run explicitly for institutional investors, like insurance companies and 401(k) plans.

The Pluses: Because they're managed for institutional investors, collective trusts don't have to market themselves like mutual funds do. Nor are they subject to the same regulatory regime or reporting requirements that mutual funds are. They're monitored by bank regulators rather than the SEC. The net effect of having to file less paperwork and hire fewer lawyers is that the collective trust fees are often lower than those of mutual funds in the same category. Many CITs are index funds, so it's probably not surprising that the median large-blend CIT expense ratio is 0.13%, versus 0.76% for conventional large-blend mutual funds. Collective trusts may also feature fund managers who, for whatever reason, do not run mutual funds at all.

The Drawbacks: Disclosure is the biggie. In the United States, mutual funds are required to provide a lot of information--daily prices, quarterly holdings, expense, and manager information. By contrast, collective trusts are subject to less-stringent reporting requirements. The regulatory requirements for collective trusts are also less stringent than is the case for mutual funds. One key difference is that mutual funds have boards of directors that are in place to serve investors' interests; the board is an additional safeguard that collective trust investors don't have. That doesn't mean that no one is watching over your 401(k) options: All investment options in 401(k) plans are governed by ERISA law. That requires their overseers to act as fiduciaries and make sure that the plans are set up to serve their investors' interests.

How to Find More Information: Morningstar.com doesn't include CIT data or analyst reports for CITs, but some 401(k) plans may provide their participants with a lot of information about collective trusts in the plan: who's running it, what it charges, and how it is performing on a day-to-day basis. If you're seeking more details on a CIT in your plan than is readily available through your 401(k) portal, start by combing through your plan's annual report (Form 5500). You should be able to find details about the collective trusts' managers, fees, investment strategies, and performance track records. Don't be shy about asking your employer or plan administrator for additional details and ask your colleagues to do the same; the demand for information will drive your employer or plan administrator to make it available.

For portfolio-tracking purposes, you may also be able to find a mutual fund clone of the collective trust in your plan. If you can get your hands on some information about the CIT, such as who’s managing it or what index it tracks, you should be able to identify a similar mutual fund that you can plug into your portfolio to get a read on your asset allocation and track performance.

Stable-Value Funds What They Are: Typically a subset of the CIT universe and only available to institutional investors, stable-value funds seek to hold investors' principal steady while offering higher yields than would be available on competing cash options. They achieve those higher yields by investing in high-quality short- and intermediate-term debt instruments rather than cash. Such investments aren't guaranteed and can fluctuate in value, but stable-value funds aim to (and usually do) maintain stable net asset values thanks to insurance contracts that effectively smooth out volatility. (Karen Wallace discusses the logistics of stable-value funds in this article.)

The Pluses: Because stable-value funds invest in bonds rather than true cash instruments, their yields can, at various points in time, be higher than true cash investments. Over the past 12 months, for example, the median stable-value fund in Morningstar's database has returned 2.12%, versus 1.82% for the median money market mutual fund. The yield differential between stable-value and money market funds can be even more meaningful when interest rates are higher in absolute terms. That yield advantage can be especially important to retirees who are actively drawing upon their 401(k)s for living expenses; some 401(k) participants leave assets in the plan after retirement rather than rolling them into an IRA so they can continue to invest in the stable-value fund.

The Drawbacks: In contrast with CDs, online savings accounts, and money market accounts, stable-value funds aren't FDIC-insured. While losses in stable-value funds would be unlikely, thanks to their insurance protection, losses are not out of the question, as discussed here. (Money market mutual funds aren't guaranteed, either, but that's a separate discussion.) Stable-value funds are often more costly than money market mutual funds, too. The median stable-value fund currently has a 0.52% expense ratio, versus a 0.34% expense ratio for money market funds. But the biggest drawback with stable-value funds is that, like any cashlike investment, long-term returns are apt to be low. Thus, they're best used as a short-term parking place unless you're actively spending from your portfolio in retirement.

Where to Find More Information: The amount of information available for the stable-value fund depends on the plan as well as the type of stable-value product. If your stable-value fund is organized as a commingled fund, you should be able to find some basic return and expense information via your plan's website or in the plan's annual report. On the other hand, if your plan's stable-value option is set up as a guaranteed investment contract, expense and other information is likely going to be harder to find. If you can't find what you're looking for, ask your employer or plan administrator for additional details.

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