We have recently seen a rise in the number of retirement plans exiting mutual funds in favor of collective investment trusts (CITs). Often the transition is simply a change in structure—that is, moving from the same investment manager’s mutual fund to its CIT counterpart. This post explores some potential reasons for this trend by comparing some key differences in the two investment fund structures.
What’s Under the Hood
A mutual fund is generally a business trust that is registered as an investment company under the Investment Company Act of 1940 and managed in accordance with a mutual fund offering document or “prospectus.” Assets of a mutual fund are typically held by a specialized bank or custodian; interest in a mutual fund is denominated in “shares”; and mutual funds are typically identified with a ticker symbol.
A CIT is established as a trust that is not registered under the Investment Company Act of 1940, with a trustee generally responsible for the management and administration of the trust and its assets. The trustee may also appoint a subadvisor to advise on the management of the trust’s assets, while typically retaining ultimate investment decisionmaking authority for itself. The trust is typically established pursuant to a declaration of trust, and investors participate in the CIT by completing a subscription document containing the legal terms of the investment.
Who Can Buy?
Mutual funds are generally available to all investors (though specific classes may be available only to certain investors meeting certain minimums or other qualifications). CITs may have to limit the scope of eligible investors depending on whether a CIT intends to qualify as a tax-exempt “group trust” under IRS Revenue Ruling 81-100 (which many do), and depending on the securities law exemptions on which the CIT intends to rely. These rules have the effect of generally limiting CIT participation to retirement plans and arrangements of various types.
Who’s the ERISA Fiduciary Here?
A key difference between mutual funds and CITs is the applicability of ERISA. Investment managers and sponsors of a mutual fund are exempt from ERISA because the shares of the mutual fund held in the plan’s trust are “plan assets” but the underlying assets of the mutual fund are not. By contrast, if there is even a single ERISA plan investor in a CIT, the underlying assets of the CIT are plan assets, subject to all of ERISA’s fiduciary and prohibited transaction rules.
Show Me the Money
One of the primary drivers behind a fiduciary’s decision to swap a mutual fund for a CIT is cost. CITs can often offer the same strategy at a lower cost by avoiding the additional costs associated with the regulatory regime applicable to mutual funds. Of course, making the move would mean the regulatory protections of mutual funds would not be automatic, and instead, the fiduciary may need to negotiate for more protective investment terms.
CITs also tend to have more flexibility than mutual funds to quickly and easily establish new investment classes at varying fee levels, which allows CITs more wiggle room to negotiate fees to attract investors with various investment amounts. That said, while CITs generally offer savings on fees and expenses, plan fiduciaries should consider other expenses in the implementation of the CIT, such as more extensive legal review and participant communications.
Moving to lower-cost investment options may also provide fiduciaries with some comfort in light of the veritable explosion in ERISA litigation we have seen in the last couple years, where many cases allege that fiduciaries chose plan investment options that were too costly.