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401(k) Plans Move to Collective Trusts

CITs Offer Lower Fees, But Less Transparency

BOSTON - Workers love pension plans, but providing 20 to 30 years of benefits to a huge retired workforce can cripple most companies' profits.

As more firms drop their defined benefit pension plans in favor of defined contribution 401(k)s, institutions are looking for qualified default investment alternatives to mutual funds, such as collective investment trusts (CITs) and separately managed accounts (SMAs), to provide employees with pension-like features.

"You want to have the best tools available to meet your goals and give your participants the best plan available," said Thomas Waters, managing director of OppenheimerFunds's OFI Institutional, at the "Defined Contribution Investment Only Forum," held here July 21-22 at the Harvard Club, and hosted by Financial Research Associates.

"Plan sponsors are looking for defined benefit-like investment vehicles," Waters said. "We need to take the best of what the DB world had to offer and bring those features to the DC market."

Mutual funds offer flexibility, transparency and easy rollovers, but also have high costs and lack customization features, said Matthew Appelstein, chief of institutional sales, marketing and product officer for Old Mutual. Collective trusts, on the other hand, offer lower costs, the ability to customize and best-in-breed management, but have lower transparency, limits on rollovers and are less popular.

Because CITs are available only in retirement plans, they tend to be much cheaper than mutual funds. CITs aren't sold to the general public and therefore don't have to comply with disclosure requirements by the Securities and Exchange Commission.

Also, CITs provide far less performance information than mutual funds, are not listed in newspapers or on financial websites and are not required to send out prospectuses. Managers of CITs must have trustee capabilities and be maintained by a bank or a trust company.

CITs can't be rolled over into an individual retirement account when a participant leaves a 401(k), meaning investors have to transfer their funds to other investment options before they attempt a rollover. They can, however, invest in hedge funds and other alternative investment vehicles and are exempt from the Investment Company Act of 1940.

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"In the past, the default option was stable value, or by stealth, company stock," said Drew Carrington, head of defined contribution for UBS Global Asset Management.

The Pension Protection Act of 2006 changed all that, requiring employers to take an active role in making sure their employees are taken care of in retirement, said Michael Siciliano, vice president of ING Investment Management.

"With one fell swoop, PPA advanced us very far," Siciliano said. "The government got it right."

Managers should offer a wide array of products, he said, including SMAs, CITs and mutual funds. The right product depends on an investor's needs.

"The whole business comes down to distribution," Siciliano said. "The differences in costs depend on who you distribute through. The trend to collective funds is not going to take over the world, but we are seeing a lot more growth in the customization space."

"There is a real evolution in the DC world taking place," said Martha Spano, a senior consultant and West division practice leader for Watson Wyatt Worldwide. "A lot of plans are using separate accounts to improve their plans by giving clients access to higher-quality, institutional products."

Spano said smaller plans around the $100 million range can make the switch to collective trusts, but the transition can be difficult. Often, the plan will need to hire a specialist transition manager.

"Most times I won't talk to a client unless they have at least $1 billion," she said. "There are definite cost efficiencies by switching. We think the cost savings are really worth the move from mutual funds to SMAs."


Many benefit experts consider target-date funds to be a godsend for participants-particularly those participants who don't change their plan from the default option-but this "one-size-fits-all" solution has its own flaws.

"In target-date funds, investment as a participant is based on one fact: how old you are," Carrington said. "We as an industry owe it to participants to get this right and find a solution that's more balanced for everyone."

There is a tremendous amount of variability in equity exposure among participants, even among those who are the same age. Some investors are willing to take more risk. Some investors may feel that they are too concentrated in one sector and want to diversify. Some may not have saved enough for their age and need to catch up by contributing more than the average.

"You have limited flexibility when you use an off-the-shelf product," said Steve Ferber, a consultant for DC Distribution Consulting. "It depends on your goals. Are you worried about inflation, or the purchasing power you have at retirement?"

"These off-the-shelf products were aimed at the common denominator," Siciliano said, "but perhaps that simplicity just isn't right for them. One size doesn't fit all."

Offering investors several options would seem to be the answer, but "customers get turned off when they have to answer more than three questions," said Cleo Chang, vice president and head of the investment research group at Wilshire Associates.

"Participants can be confused by both off-the-shelf and customized products," Waters said. "These are by no means easy solutions."

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