Collective Wisdom
Collective funds, or collective trust funds (CTFs) as they sometimes are called, have long been the Rodney Dangerfields of the 401(k) investment menu. If they have not exactly been struggling to gain the “respect” of advisers and plan sponsors, they certainly have had to overcome a series of misperceptions and dated assumptions about their capabilities and suitability.
Collective funds are not exactly new; the first collective investment fund was offered in 1927, a year before the first mutual fund was marketed to the public. In 1955, the Federal Reserve authorized banks to pool funds from pension, profit-sharing, and stock bonus plans. The Internal Revenue Service (IRS) subsequently ruled that such funds could be tax-exempt. In fact, until the 1980s, collective funds were a common retirement plan investment vehicle. It was at that time that mutual funds—with their daily valuation, nightly trading, call center support infrastructures, and “free” administration—began to emerge as the 401(k) plan investment vehicle of choice.
Things have changed, however. Collective funds now offer the same trading flexibility as mutual funds and, with an increased scrutiny on fees and fee disclosures, they can offer plans a truly cost-effective alternative. As plan sponsors continue to look to their advisers for guidance about their fund lineups, advisers should ensure they have their facts straight about what collective trust funds are and how they work.
Valuation. Unlike those bank-managed funds (back in the 1980s) that did not offer daily valuation, today, daily valued—and, more importantly, daily traded—collective trusts are the order of the day though the National Securities Clearing Corporation (NSCC), a subsidiary of the Depository Trust & Clearing Corporation.
Availability. As with any fund choice, plan sponsors know that “open architecture” does not necessarily mean “all-inclusive.” However, John Kutz, Managing Director, Retirement Plan Services, at Cleveland-based Victory Capital Management, notes that “many plan sponsors simply are not aware that CTFs currently are available on many of the retirement plan platforms.” The surest way to find out what is available for a client’s plan is to ask the recordkeeper.
Regardless of plan size, it is increasingly likely that advisers can help plan sponsors find a fit for their needs. Wilmington Trust’s standard program offers several share classes per fund, each with its own fee structure, which, according to Charles Russella, Senior Vice President, Wilmington Trust Retirement and Institutional Services Company, “can accommodate distinct variations in plan size, the level of services required, and the desired level of revenue-sharing.” Hand Benefits & Trust also offers share classes for its funds that are suitable for revenue-sharing arrangements with third-party administrators (TPAs) and advisers. Jim Danaher of Northern Trust’s Global Defined Contribution Solutions group notes that advisers/consultants who provide their services on a fee-only basis are “generally indifferent” to the use of a mutual fund, collective trust, or even separate account.
Design. It has been remarked that the operating design of the 401(k) has been influenced, if not shaped, by the retail mutual fund industry. In contrast, collective trust funds are limited to qualified retirement plans and, as such, have the same basic type of investor, the plan participant, notes Alan Dunaway, Vice President, Business Development, at Memphis-based First Mercantile Trust Company. “Mutual funds, by contrast, are available to a variety of investors both institutional and individual. Since investors in collective trust funds are limited to qualified plan participants, their investment time horizon tends to be long-term in nature.”
Similarly, launching target-date vehicles through a collective trust structure was a deliberate action on Northern Trust’s part. Observes Danaher, “Since the only investors permitted in collective trust funds are ERISA-qualified retirement plans and the largest investor group in target-date vehicles [is] self-directed DC plans such as 401(k)s, collective funds insulate these investors from the trading activity found in retail-oriented mutual fund products.”
Moreover, collective trust fund proponents claim those structures offer significant business advantages. David Hand, CEO, Hand Benefits & Trust, notes that the Houston-based firm was able to take advantage of the “low cost and speed to market, with flexibility in holdings,” that a collective trust fund structure offered in repositioning its SMARTfunds to take advantage of new regulations regarding qualified default investment alternatives (QDIAs).
Collective trusts traditionally have been at a disadvantage relative to their mutual fund counterparts in terms of access to performance data. That, however, is changing, though new offerings—and there are a number of those—may well lack the requisite history for relevant comparisons. “[Still,] plan sponsors often do not realize that critical investment data on collective trust funds is as readily accessible on a periodic basis as it is for mutual funds,” notes Danaher.
In the experience of Dunaway: “The most common misconception about collective trusts is that there is a lack of fee transparency and regulatory oversight. Actually, it’s quite the contrary. Each plan sponsor must sign a participation agreement to invest in a collective trust. The participation agreement discloses the fees that will be charged to participate in the trust. In addition, the underlying trust document establishing the collective trust must detail the charges and expenses.”
Transparency. Dunaway notes that collective trust funds are established by banks, and national and state chartered banks are governed by a number of regulatory bodies, including the state’s Office of the Comptroller, the Federal Reserve, as well as state banking regulators. “Each regulatory body has procedures and examination requirements regarding the operation of collective trusts.”
Fee transparency may aid in the growth of collective trust fund assets, but a larger factor may be the opportunity for plan sponsors to reduce investment management costs to plan participants, notes Kutz.
Are collective trust funds truly less expensive? Well, as with any fund choice, the truthful answer nearly always will be “it depends”—on the provider, the type of fund, and, yes, the underlying fund structure. Still, the reality, generally speaking, is that mutual funds have higher operating costs (and fees) than comparable collective funds. Indeed, a recent report by Victory Capital Management indicates that “the cost advantages CTFs have over their mutual fund counterparts can be significant, up to 25% for some investment styles.”
Still, Dennis Sain, President of Sain Management Solutions, Inc., cautions that not all collective funds are embracing this advantage. “Some have established high entry thresholds,’ he notes and others are priced nearly as high as comparable mutual funds.
Citing the relative simplicity of collective trust design, Russella sees a bright future: “We expect to experience continued growth in our collective trust funds as the industry—clients, advisers, and regulators—continues to demand lower fees and greater transparency.”
Illustration by Ted McGrath