July 8, 2010

Branching Out

Collective trusts gaining sponsor acceptance, but ETFs have limited appeal

Reported by Judy Ward

Collective trusts “are beginning to make more headway in the larger-plan market” with $500 million and up in assets, says Brian Ward, a Managing Director at Ward Financial Advisory at Wells Fargo Advisors in Brentwood, Tennessee. While he currently sees the most interest from that end of the market, he says those trusts are also being marketed to smaller plans with less than $10 million in assets. These sponsors feel comfortable about the greater amount of control they have with collective trusts than mutual funds, and get lower fees in return.

“You take control of the investment-manager selection, the glide-path design, the pricing, and the fiduciary oversight,” Ward says. “Some employers do it in-house, and others say, ‘Why do we want to take that responsibility on?’ Lots of advisers and consultants are happy to take that on.”

Also, make sure a plan’s recordkeeper can handle a collective trust the way the employer wants. Doubts about that have kept some sponsors from adopting these trusts, says Paul D’Aiutolo, a Rochester, New York-based institutional consultant at UBS. Some sponsors also worry that these trusts lack enough transparency or performance history for participants, he says. “There are lots of positives at the sponsor level, but also concerns about the reaction at the participant level, when they give people something that does not have a lot of history,” he says. Many participants still like to look up their mutual funds in a newspaper, he says, or plug in ticker symbols online.

Advisers considering their usage also should examine the trust agreement itself, since these trusts can engage in securities lending, says Thomas Clark Jr., a Vice President at Lockton Investment Advisors, LLC, in Washington. Find out: How much securities lending can the trust do? Of the profits made in securities lending, how much of that is shared with participants? “Some collective trusts ran into issues in 2008, because of the amount of money they had leveraged,” he says. “It can be a very good way to save on fees, but our advice is to go in with your eyes wide open, because not all collective trusts are built the same.”

Unlike collective trusts, sources say, exchange-traded funds (ETFs) have not made much headway in the 401(k) market. “Not that many vendors will recordkeep the ETF, so that limits their popularity,” Clark says. In particular, he says, the bundled vendors used by many large employers frequently do not handle ETFs, although third-party administrators (TPA) often do.

“One thing that you have to be careful of with ETFs is that participants are not going to have intraday trading, and they are not going to have the tax advantages of ETFs,” Clark says. For retail investors, ETFs do not have some of the capital-gains liability issues that mutual funds have, but the capital-gains tax does not apply to 401(k) money. As he says, “Some of the advantages that we see in the retail world are not going to matter in retirement plans.”