Until a couple of years ago, 401(k) investors could pretty much count on plump returns, so they weren't paying a whole lot of attention to the costs of mutual funds within their portfolios. But the market's turmoil since then, along with some high-profile lawsuits, has turned a spotlight on mutual funds' pricing, and that has spurred a resurgence in a product that many 401(k) plans had historically neglected: collective investment trusts. That's good news for banks, since CITs must legally have a bank or trust company as a trustee.
CITs invest in stocks, bonds and other securities and, unlike mutual funds available to retail customers, are aimed solely at retirement funds. Robert Thomann, the president of Invesco National Trust Co., a unit of asset manager Invesco Ltd., said in January that he expects his firm to book more CIT business in the first few months of this year than it has in the last two years combined.
According to Morningstar Inc., CIT assets within defined-contribution plans reached $800 billion in 2009, up from $236 billion five years earlier. CIT assets accounted for 11.8 percent of the defined-contribution market last year, up from 3.6 percent in 2004, and Morningstar analysts expect CITs to continue gaining share in coming years.
It's not hard to understand why CITs are catching on within 401(k) plans. CITs can cost as much as 25 percent less than comparable mutual funds. The savings also appeal to employers for legal reasons, as plan sponsors can be sued over high fees. When equipmentmanufacturer Caterpillar settled such a suit last fall, part of the agreement was that it must offer cheaper options such as CITs within its retirement plan. That has not been lost on other employers, experts say.
Even before the market crash and the Caterpillar suit, CITs were on the march. At the end of 2008, 45 percent of corporations with defined-contribution plans offered CITs, up from 32 percent in 2003, according to the research firm Greenwich Associates.
CITs got a boost by the passage of the Pension Protection Act of 2006, which permitted employers to automatically enroll their workers in 401(k) plans that offered the investment vehicles. But over the past year, CITs' popularity seems to have reached a "tipping point," says Steve Deutsch, director of separate accounts and collective investment trusts at Morningstar.
Banks or trusts can manage CITs and offer them directly to the retirement market, while nonbank asset managers that want to offer CITs must either form a bank or trust unit, as Invesco did, or partner with a bank.
The growing popularity of CITs has been a boon for Wilmington Trust Corp., a Delaware banking company with 65 asset manager partners. Its retirement and institutional services arm has increased its CIT assets under administration by roughly 60 percent in the last two years to about $8 billion, according to Charlie Russella, president of the unit.
Partnerships with asset managers are appealing because they can earn banks as much as a tenth of a percentage point annually on the assets within a CIT, industry experts say. "Banks like State Street and BNY Mellon have been very active in reaching out to all the money management firms," says Morningstar's Deutsch.
The fact that CITs are bank products helps to explain their cost advantage. Unlike mutual funds, they are not required to have boards of directors, for instance, or to produce and distribute documents like prospectuses and proxy statements. And because they're marketed directly to the gatekeepers who can get them into retirement plans, they don't have marketing and branding budgets. The lower costs can add up to tens of thousands of dollars in extra cash over the life of an individual's retirement plan, experts say.
Like mutual funds, CITs have been around since the 1920s. They have long been a staple of traditional pension plans and in the early days of 401(k)s, they had a sizeable presence there as well. But by the late 1980s, CITs were falling out of favor because of their technological limitations. "Only [mutual funds] had the ability to be priced and traded daily," says Russella. The CIT industry "didn't have a good trading platform." Now, plan participants can now do things like track the price of their investments every day.
CITs face competition from exchange-traded funds, low-cost baskets of securities that trade on the stock market. And separate accounts, a more traditional investment vehicle within retirement plans, remain popular. But a bigger impediment to CITs' rise within 401(k)s may be the investing public's unfamiliarity with them. Part of the reason mutual funds are more expensive, after all, is that they have large marketing budgets. "They've had a 30-year head start," says Russella. "That helps a lot."