What are CITs?
CITs, which are sometimes called Collective Trust Funds (CTFs) or Collective Investment Funds (CIFs), have been in existence since 1927 and operate today in a similar way as mutual funds. The main difference between a CIT and a mutual fund is that a CIT is sponsored by a bank or trust company (Trust Company) and is therefore subject to state and/or federal banking rules and regulations, while a mutual fund is regulated by the Securities and Exchange Commission (SEC). Because Trust Companies are favorably exempted from the Securities Act of 1933 (see Section 3(a)(2)) and from the Investment Company Act of 1940 (see section 3(c)(3)), they are typically less expensive and more suited to retirement plans as a vehicle. CITs are able to operate in a way that is fully compliant with banking and federal regulations but which avoids the sometimes burdensome rules and costs associated with operating a mutual fund. The savings of time and money can be passed on to the end users of the CITs, namely the retirement plan participants, who benefit from what are typically lower fund costs and a higher standard of fiduciary oversight.
After many years the retirement market has seen a number of events that have lined up for a potentially large shift in the retirement plan marketplace away from mutual funds and towards CITs.
1. CIT VALUATIONS
Over the past two decades CITs have caught up with the times and now almost all CITs are now valued on a daily basis.
2. CITS AND THE NSCC
In November 2000, the National Securities Clearing Corporation (NSCC), a subsidiary of the Depository Trust & Clearing Corporation (DTCC), began assigning cusips to CITs and allowing them to trade on its platform. This change meant that CITs could now trade alongside mutual funds and be made available to virtually every retirement plan custody platform, significantly broadening their distribution potential.
3. DOL FEE DISCLOSURES
In July 2012, the Department of Labor finalized and implemented its new disclosure rules under rule 408(b)(2). This rule requires all covered service providers to disclose their fees in a uniform way, causing many providers to find ways to lower their fees. One of the ways plan providers try to achieve this is by replacing their more costly mutual funds with lower cost CITs.
In addition, many advisers that have operated 401k model portfolios have chosen to use CITs to simplify their operations, to lower underlying security expenses and to provide uniform disclosures and performance.
4. FIDUCIARY OVERSIGHT
Second only to the persistent discussion of retirement plan fees, the fiduciary status of retirement funds is the most discussed issue in the retirement industry. The DOL has made fiduciary status a hot button issue over the last decade. Even though the “Fiduciary Rule” never went into effect, it created great awareness of the need for proper fiduciary oversight and many of the rule’s proposals will likely stay ingrained in the industry, even without a final rule.
The question “Who is a fiduciary of the plan?” is constant. What many retirement professionals have become aware of in recent years is the fact that mutual funds are specifically exempted from ERISA fiduciary oversight status in retirement plans,5 meaning that mutual fund investment managers are not plan fiduciaries. CITs, on the other hand, add fiduciaries to retirement plan assets. For instance, the Trust Company is a fiduciary to each CIT sponsor and to all of the assets contributed to those CITs. Additionally, the Investment Manager to a CIT is typically a 3(38) investment fiduciary under ERISA and is responsible for properly investing the assets of each CIT it serves. Both are specifically tasked with providing fiduciary protection to plan sponsors for the assets they manage.
5. MORNINGSTAR CIT DATABASE
In 2007, Morningstar added credibility to the growing CIT movement by creating a CIT database that gave plan advisers and plan sponsors a way to screen CITs, just as they do with mutual funds. For years CITs had been criticized for not being transparent. Now retirement plan service providers can receive data on CITs in a very similar way to mutual funds.
6. LOWER BARRIER TO ENTRY
In the past there have been financial barriers for money managers who were looking for a Bank partner to set up CITs. The sponsoring Trust Companies would often charge high set up fees and would require significant asset minimums to start a fund. Over the last few years we have seen some of these barriers come down with some Trust Companies.