Collective investment trusts (CITs) have become increasingly popular investment options for Employee Retirement Income Security Act (ERISA) plans as fiduciaries seek to lower investment management fees.
What are CITs, and what do fiduciaries need to know before investing in them? That’s the topic of an article in the May/June issue of Benefits Magazine by attorney Michael T. Joliat. He explains how CITs are different from other investment options and offers a process for reviewing the appropriateness of CITs.
CITs Defined
According to Investor.gov, CITs are pooled investment vehicles that “combine the money of multiple investors into a single portfolio with a specific investment strategy.” They are maintained by banks and trust companies.
What Types of Plans May Invest in Them?
Defined benefit (DB) and defined contribution (DC) ERISA plans, including 401(k) plans, may invest in CITs, but 403(b) plans may not invest in CITs. Legislation to allow 403(b) plans to invest in CITs was introduced in the U.S. House of Representatives this year and passed out of committee in May, but no further action has been taken since.
Like Mutual Funds, But Different
The differences between CITs and mutual funds are neither all positive, nor all negative, Joliat writes in the Benefits Magazine article.
In the early 2000s, investment firms began collaborating with banks and trust companies or establishing their own affiliated bank or trust companies to offer CITs, and these vehicles often offer the same underlying assets as the investment firm’s mutual funds, he explains. However, the investment management fees are usually lower than those of the sibling mutual fund. CITs may also be more flexible. For example, they may allow custom pricing arrangements, according to State Street Investment Management.
As the number of investment fee–related lawsuits against DC plan fiduciaries has grown over the last decade, the prospect of lower fees has become attractive to fiduciaries. As a result, many ERISA plan fiduciaries are choosing CIT investments over mutual funds as investment options in DC plans. The percentage of DC plan assets held in CITs has more than doubled—from 13% to 30%—over the past decade.
The tradeoff for the lower fees is less regulation, Joliat notes. While mutual funds are regulated by the Securities and Exchange Commission (SEC), CITs are regulated by the Comptroller of the Currency or state banking authorities.
It’s assumed that because CITs are limited to institutional investors, these investors have the knowledge and the bargaining power to safeguard their own interests, Joliat adds. In addition, CITs may have less favorable terms on transparency, accountability and liquidity when compared with mutual funds.
The article goes on to describe several of the differences between the two vehicles.
Fiduciary Duties and Investing in CITs
Joliat explains that ERISA requires plan fiduciaries to:
- Employ appropriate methods to investigate the merits of an investment and to structure the investment
- Engage in a reasoned decision-making process, consistent with that of a prudent person acting in a like capacity
- Monitor the prudence of their investment decisions to ensure that they remain in the best interest of plan participants.
With this in mind, Joliat offers the following steps for plan fiduciaries considering investing in a CIT.
- Determine that the investment is a CIT. “Investment advisors do not always appreciate the differences between CITs, mutual funds and other investment vehicles. As such, an advisor may not offer up the fact that a recommended investment is a CIT. Plan fiduciaries should ask,” he writes.
- Review the terms. Plan fiduciaries should recognize that CIT terms can vary quite dramatically, and some terms can be unfavorable. Plans with large investments may be able to negotiate better terms. Plans with smaller investments may want to consider how the cost of hiring counsel would affect return and evaluate whether CITs are an appropriate vehicle with that in mind.
- Negotiate. If the plan counsel identifies concerns with the agreements for a potential CIT investment, they can help plan fiduciaries negotiate with the investment management firm and bank that offer the CIT.
“CITs are on the rise. What was once the exclusive domain of the largest employee benefit plans is fast becoming a part of plans across the spectrum,” Joliat concludes in the article. “Plan fiduciaries should be aware that CITs are different from mutual funds and prudently evaluate the impact of those differences. Plan fiduciaries should generally consult legal counsel with appropriate expertise when considering a CIT investment.”
