Interest in Collective Investment Trusts (CITs) continues to accelerate in the retirement plan market. When plan fiduciaries are constructing a plan investment menu there are several factors that should be considered. Examining things such as investment eligibility, availability of information, fiduciary considerations and ongoing monitoring and oversight are just a few of these factors. We recently hosted a webinar on Collective Investment Trust Governance with the authors of our most recent whitepaper, Collective Investment Trusts and Good Governance Considerations. We received some great questions that our authors answered below. Learn more about the importance and process of CIT Governance. Here are the answers to some common questions on CITs to help plan fiduciaries make informed decisions.
CIT Eligibility and Adoption
Adoption of CITs seems low in spite of the financial benefits and the fiduciary benefits of the CIT structure. What is Wilmington Trust is doing in terms of plan-sponsor directed PR to encourage adoption?
First, we would disagree with the suggestion that rates of CIT adoption are low. According to Morningstar, collective investment trusts have benefited from the trend toward lower fees. The market share of CITs has grown to roughly 40% as of March 2020, up from less than 20% in 2014.
Second, at Wilmington Trust, we have seen a strong and accelerating trend toward the adoption and use of CITs as lower cost alternatives to mutual funds. The trend is most pronounced in the large plan market but is steadily migrating into the mid and smaller-plan space. Wilmington Trust continues to educate advisors and plan sponsors on the benefits of utilizing CITs within a retirement plan.
Oftentimes, we can’t find the CIT with the same strategy, thus the issue of fees becomes a bit beside the point. I would also note that recently, we found that the CIT for the S&P 500 indexed was actually a bit higher than the 500 index fund we were able to get through Fidelity.
While CITs have certain expense advantages relative to mutual funds given the inapplicability of ’40 Act prospectus filing and updating and similar ongoing periodic reporting requirements, there are instances where the scale of assets invested in certain strategies – such as the S&P 500 strategy you identify – is so significant that the mutual fund management fee may be lower than a CIT counterpart fund due to economies of scale and a way to attract investors to the fund complex. While CITs are generally less expensive relative to comparable mutual fund products, there are certainly exceptions. Accordingly, plan sponsors and advisors will want to continue to evaluate the varying features of CIT and mutual fund products, including cost differentials, when engaged in plan investment option decision making.
Can a fiduciary (the retirement plan committee) make an acceptable fiduciary decision not to use a CIT for the reasons of the inability to show a track record when a new CIT is put together? In the end, participants will not see any track record.
A plan investment fiduciary has a duty to prudently consider and evaluate relevant information based on the particular facts and circumstances. The absence of a performance “track record” for a new CIT would certainly be a relevant consideration, but not the only consideration. Others would typically include fees and expenses, sub-advisor team tenure, and, of course, the quality of the CIT provider itself. There is no per se rule precluding the selection of a newly started fund and, as you know, past performance is not an indicator of and can not guarantee future success.
Are CIT’s eligible inside a 401(a) or 457(b) plans?
Yes. Code section 401(a) qualified plans and section 457(b) governmental plans are both eligible to participate in CITs.
Accessing CIT Information & Reporting
The DOL expects plan sponsors to provide their plan participants enough information in order to make informed decisions. Can CITs satisfy this expectation from publicly available information compared to mutual fund offerings?
Wilmington Trust provides full support for plan administrators to fulfill their disclosure obligations to participants under ERISA Reg. 404a-5. Wilmington Trust provides plan administrators with CIT performance and expense information that is regularly reported and updated, along with fact sheets that include details such as fund investment objectives and strategies and performance.
What is the frequency of fund fact sheet availability and are there differences in how or when participants can access these as compared to mutual funds?
Wilmington Trust produces quarterly Fact Sheets that are available on our website by the end of the month following quarter end for use by institutional investors, such as the plan sponsor. The quarterly Fact Sheets contain investment objective and strategy, performance data and portfolio analysis including top 10 holdings. Participants typically have access to quarterly CIT fact sheets via the recordkeeper’s participant website in the same manner as the mutual fund fact sheets.
When a participant logs into their plan account online, do they see the most current price and recent performance?
Yes. Wilmington Trust submits prices to trading platforms and recordkeepers on a daily basis so they are available for participant online accounts. In addition, many of our collective fund prices and performance are published daily on Nasdaq and Morningstar Direct and some recordkeepers receive feeds from these services as well to populate participant websites.
All investments have to be scored for the benefit of investment committees at least quarterly for self-directed retirement plans. What is the process to provide CIT data to vendors so reports can be produced?
CIT data has become more readily available over the last several years as CITs have gained in popularity. Unlike mutual fund data, CIT data is self reported by the CIT provider. Providers have become more cognizant of the need to have timely information available and have begun providing this information on a regular basis to vendors. For Wilmington Trust specifically, pricing and performance is published daily on Nasdaq and Morningstar Direct.
When CITs reinvest dividends, how do they disclose this in their fact sheets?
Tax rules, including the reporting of dividend income, differ between mutual funds and CITs. Mutual funds, which may have a mix of tax advantaged and non-tax advantaged investors are required to track and distribute dividends to shareholders to facilitate the reporting of taxable income by non-tax advantaged investors. But a CIT is by definition a tax-exempt vehicle that is available only to certain other tax-advantaged investors (e.g., 401(a) qualified plans). Accordingly, there is no need to track or report CIT dividend income, which is automatically re-invested by the CIT.
What political action are you taking to facilitate the legalization of CITs in 403(b) plans?
On the 403(b) front, Wilmington Trust is actively engaged with our industry partners and trade organizations to inform and educate legislators and their staff about the cost savings opportunities and other benefits associated with CITs. We are extremely pleased that the SECURE 2.0 legislation currently being considered by Congress includes provision that would grant the 403(b)- plan community with access to CITs.
In your opinion, how likely is it that legislation will pass to allow 403bs to invest in CITs?
We are optimistic about the prospects for passage. The “SECURE 2.0” legislative package under consideration by Congress includes provisions that would amend the Tax Code and the ’40 Act to allow 403(b) plans to participate in CITs. The legislation enjoys widespread support, as it would increases the availability of relatively low-cost CIT products to retirement savers.
With the recent DOL compliance guidance on crypto and the emergence of National Chartered Digital banks, how is Wilmington Trust considering the custody of digital assets?
The DOL’s recent Compliance Assistance Release signals the Department’s high level of concern with the investment of ERISA plan assets in cryptocurrencies. The DOL’s concerns are not limited to custody issues, but also include questions about the reliability and accuracy of valuation and the speculative and volatile nature of cryptocurrency markets. Given the magnitude of the Department’s concerns, Wilmington Trust does not intend to offer CITs with cryptocurrency-focused investment strategies at the present time.
How are mutual funds not considered an ERISA plan asset?
When an ERISA plan purchase shares of mutual fund, the shares themselves are plan assets, but the underlying holdings of the mutual fund are not. That distinction is found in ERISA section 401(b)(1), which provides that, in the case of plan which invests in a security issued by a ’40 Act registered investment company (i.e., a mutual fund), “the assets of such plan shall be deemed to include such security but shall not, solely by reason of such investment, be deemed to include any assets of such investment company.” Since ERISA’s fiduciary status is assigned to those who exercise of authority or control over “plan assets” the non-plan assets status of mutual fund holdings means that mutual fund managers are not subject to ERISA’s fiduciary responsibility rules. For CITs, both the plan’s units of the CIT and the CIT’s underlying holdings are plan assets. The CIT trustee that manages those assets is responsible as an ERISA fiduciary.
Investment Monitoring & Oversight
How often does Wilmington Trust review fund / sub-adviser investment strategies and results?
Wilmington Trust’s Investment Products Oversight Committee (“IPOC”) is core to our CIT governance approach. The IPOC meets on a regular, scheduled basis monthly. When warranted, special meetings are called to address any emerging, time-sensitive issues. On at least an annual basis, the IPOC performs an in-depth review of each sub-advisor, including its management personnel, consistency of style and approach and level of success in meeting CIT investment objectives. The annual review process is required by the OCC Reg. 9 and is conducted with a view to ensuring that CIT assets are being invested in a manner consistent with investment objectives and guidelines and to reaffirm or make changes to CIT investment objectives and guidelines as appropriate.
What happens when a sub-advisor is replaced?
From time to time, Wilmington Trust’s level of concern with respect to a given sub-advisor may become so significant as to merit replacement of the sub-advisor and/or termination of a CIT. Sub-advisor replacement, without a termination of the affected CIT, tends to occur most frequently, in multi-fund, multi-sub-advised strategies (e.g., a target date CIT). In a standalone CIT, where the identity of the CIT sub-advisor is likely to have materially influenced the CIT’s selection by a participating plan, a CIT termination decision would likely accompany a loss of confidence in the sub-advisor. Under both scenarios, reasonable advance notice of the change is furnished to participating plans.
What additional monitoring would be involved if our clients add CITs. Have there been any court cases involving fiduciaries and additional due diligence needed on CITs?
The plaintiffs’ class action bar has brought numerous cases in recent years alleging fiduciary breaches by plan sponsors for failure to adequately monitor plan investment options and levels of expense. A number of complaints are harshly critical of plan sponsors for alleged failures to adequately explore the use of CITs as lower cost alternatives to mutual fund products. When evaluating and selecting among available funds to serve as plan investment options, plan sponsors are subject to duties of prudence and loyalty. In our view, inquiring about the experience of a CIT provider and its approach to managing fund governance would be consistent with fulfilling those ERISA duties.
When a new CIT is created which “clones” an existing ’40 Act Fund, how should we address Investment Policy Statement and performance history considerations?
The history of the mutual fund from which the CIT offering is cloned (the “Related Fund”) is generally useful to plan sponsors as an indicator of how a fund with an identical investment strategy and investment management team (typically) may perform. Since the CIT and the Related Fund are different pooled investment vehicles, it is important to consider the performance histories of the two as related but separate performance histories. With that in mind, Related Fund and CIT performance may be reported to plan sponsors together, so long as safeguards are taken to avoid the potential for misunderstanding or investor confusion.
What type of governance and oversight is applied towards securities lending within CIT’s? As trustees, how do you help manage this perceived increased risk for 401(k) plan sponsors?
Certain investment strategies utilize securities lending with a stated goal of enhancing levels of return. Under a securities lending program, borrowers of the CIT’s securities put up collateral, in the form of cash or non-cash securities, of value equal to or greater than the loaned securities. The collateral is invested until the borrowed securities are returned; a portion of the returns generated by the investment of collateral is retained by the CIT. Securities lending programs also involve the assumption of certain risks, including counter-party default risk and collateral investment risk such as the risk that the return on the cash collateral is insufficient to cover the fees the CITs are committed to pay and the risk that cash collateral may be invested in securities or other instruments that suffer losses or become illiquid.
Plan sponsors and their advisors are informed as to whether a CIT engages in securities lending and will want to prudently consider whether the additional risks associated with the program are sufficiently counterbalanced by the potential for enhanced returns. Wilmington Trust’s governance and oversight practices include inquiry related to CIT securities lending programs and the sound management of those programs, including collateral investment practices.
3(38) Investment Fiduciary
Am I to understand that utilization of CITs in a 401(k) plan present fiduciary protection? Meaning, the CIT is a 3(38) solution? if so, how does that interplay with plan sponsor delegation of ERISA investment fiduciary services?
Wilmington Trust, like many CIT providers, acknowledges fiduciary status with respect to the management of plan assets invested in the CIT and accepts an appointment as the plan’s 3(38) investment manager for that purpose. Consequently, the appointing fiduciary (i.e., the plan sponsor) is insulated from any liability for Wilmington Trust’s day-to-day CIT investment management decisions, but retains responsibility to prudently monitor and oversee Wilmington Trust. So “yes,” there is a level of fiduciary protection that comes with the appointment of Wilmington Trust as a 3(38) investment manager. To avoid any potential for confusion: Wilmington Trust does not act as a section 3(38) investment manager over plan investment option selection. We appreciate that a number of advisors offer those services and want to be clear that Wilmington Trust’s responsibilities for managing plan assets in the CIT are entirely separate from those related to investment option monitoring and selection.
I am a bit confused about the references to Wilmington Trust’s serving as a section 3(38) investment manager. Typically, the plan’s advisor will function as a 3(21) or as a 3(38) to assist with the selection and monitoring of plan investment options? Are you telling me that Wilmington Trust would serve in that role?
In a word, “no.” We want to make sure there is no confusion on that subject. Wilmington Trust does not serve as a section 3(38) investment manager for purposes of selecting the investment vehicles made available as designated investment alternatives under a 401(k) or similar defined contribution plan. Where Wilmington Trust does function as a 3(38) investment manager is with respect to the investment of plan assets contributed to the CIT itself. In that regard, it may be helpful to keep in mind that CITs are ERISA “plan assets” vehicles, unlike mutual funds, which are not plan assets vehicles. When managing the assets of a CIT, Wilmington Trust is responsible as an ERISA fiduciary. The appointment of Wilmington Trust as a section 3(38) investment manager with respect to that asset management function is protective of the plan sponsor or advisor electing to participate in the CIT.
The protection of having a CIT trustee as ERISA 3(38) investment manager was addressed earlier (above) from the perspective of the plan sponsor who selects a CIT for its plan’s investment menu. Does the CIT trustee’s 3(38) status provide any other comfort to the plan sponsor and plan participants regarding the operation of the CIT?
As an ERISA 3(38) investment manager, the CIT trustee is responsible for the investment and management of CIT assets. Many CIT trustees appoint investment sub-advisors to assist them in the investment process. The sub-advisors typically are appointed as ERISA 3(21) investment advisors. Both the CIT trustee and the investment sub-advisors are ERISA fiduciaries; however, as the appointing fiduciary, the CIT trustee is responsible to monitor and oversee the trading activity and performance of the investment sub-advisors and to take action if things go wrong. The CIT trustee’s experience, robust governance procedures, and skilled personnel are essential factors in determining how effectively it manages that oversight responsibility. Having an active and engaged CIT trustee is inherently protective of investing plans and their participants. Typically, the plan sponsor, as the plan’s named fiduciary, or a plan-level 3(38) investment manager (i.e., the 3(38) empowered to select and monitor the plan’s investment option menu) that has been delegated the power of appointment enters into the CIT participation agreement that confers investment management authority to the trustee with respect to assets contributed by the plan.
What three things truly differentiate one trustee from another?
There are a number of differentiators among CIT providers, including service levels and fees. At a qualitative level, we think the top three things to inquire about are (i) depth and breadth of experience; (ii) presence or absence of robust, well-managed governance processes; and (iii) quality and expertise of personnel. At Wilmington Trust, we pride ourselves on excelling in each of these areas.
Why would CIT provider be of such concern when the CIT is a clone of the 40 Act fund?
A CIT is an ERISA plan assets vehicle, unlike a mutual fund. And the trustee is responsible as a fiduciary for managing the assets of the CIT. The CIT trustee’s governance procedures lie at the heart of how it goes about the business of managing those responsibilities, including ongoing review of sub-advisor trading and performance activity, and vendor management. A key point to keep in mind is that a CIT trustee does not function as a mere custodian, but is substantially and actively involved in CIT management.
What steps do trustees take regarding co-investor risk in making sure liquidity is available to all plans in times of liquidity events for CITs with small asset bases?
Each CIT maintains sufficient levels of liquidity to meet anticipated day-to-day transfer and redemption needs. In the event of an unanticipated, large redemption request (generally, $1 million in the case of small asset base Fund), Wilmington Trust will intervene if appropriate to ensure that transaction costs associated with a participating plan’s redemption do not disadvantage remaining plans. Available measures include satisfying the redemption through an in-kind payment, or by utilizing a transition account to assure that the costs of liquidating assets to satisfy the redemption are borne by the redeeming plan.