CITs Continue Dominance in DC Plans But Face Limitations

As collective investment trusts are becoming increasingly more popular in defined contribution plans, a new Cerulli report questions whether mutual funds will remain a competitive investment vehicle in the future.

While CITs are often overshadowed by their more well-known mutual fund counterparts, Cerulli argued in its new “The Cerulli Edge” report for Q2 that CITs have gained market share and are overtaking mutual funds in 401(k)s.  

When considering the benefits of offering a CIT, as opposed to a mutual fund, 66% of respondents said they consider lower cost and fees as the most significant benefit, and 18% cited the ability to negotiate fees.

Adam Barnett, senior analyst at Cerulli, explained in the report that because CITs are available only to individual investors through DC plans, asset managers do not have to expend capital to market those funds to retail clients.

“This reduction in fees begins at the top and trickles down to participants, allowing for high-quality, low-cost-profile investment options,” he stated.

However, there are some downsides to CITs. For one, CITs have been excluded from 403(b) plans to the detriment of asset managers, plan sponsors and participants, according to Cerulli. Legislation that has passed in the U.S. House of Representatives and is pending in the Senate would authorize the use of CITs in 403(b) plans, and according to Cerulli, “the question now is not if this will pass, but when.”

It could take time before CITs are placed on 403(b) investment menus once the law is signed, but the Cerulli report pointed out that 403(b) plan sponsors will need to be educated about how CITs work, as many plan sponsors are not accustomed to these new asset vehicles.

Asset managers also indicated in Cerulli’s survey that there is a lack of sufficient knowledge among advisers regarding CITs, as 91% of those surveyed regarded this lack of understanding as a significant or somewhat significant challenge to further CIT adoption. In addition, 94% of asset managers said plan sponsors and advisers having issues accessing clean and comparable data on CITs within databases poses a challenge to further adoption.

Data reported by PLANSPONSOR shows that mutual funds are continuing to hold their own despite the rise of CITs, according to ISS Market Intelligence’s latest first quarter 2024 edition of the “Windows into Defined Contribution” series.

As of Q1 2024, fund and trust assets in the adviser-sold defined contribution market reached $1.27 trillion, based on data from the ISS MI BrightScope NEXUS consortium, which included input from 44 asset managers and recordkeepers, mainly focusing on small- and mid-sized plans. BrightScope, like PLANSPONSOR and PLANADVISER, is owned by ISS STOXX GmbH.

The adviser-sold market encompassed numerous plans managing smaller asset pools, unlike the consultant-driven market, which included fewer plans with substantial assets, the BrightScope report noted.

Because advisers are less familiar with CITs, they may have a harder time explaining the differences to plan sponsors who are considering adoption, Cerulli found. This may not be as much of an issue with mega 403(b) plans, as their national consultants have likely been selling CITs to their 401(k) clients for years, but for smaller, less advised plans, “lack of education likely will be a barrier to adoption,” the report stated.

With mutual funds, Cerulli found that they tend to have a stronger foothold in the micro and small plan segments because CITs’ investment minimums have often been too large for smaller plans to meet. According to SEI Investments, nearly 70% of asset managers enforce a minimum asset requirement on their CITs. As a result, it is important for plan sponsors to consider whether a minimum exists and what they can expect that threshold to be.

Cerulli predicts that mutual funds will remain a viable option for the smallest plans. While some micro-market recordkeepers, like Vestwell and Guideline, offer exchange-traded funds on their platforms, many of the more long-standing recordkeepers do not.

Also, plan sponsors and advisers without the scale to negotiate custom fee arrangements or access to cheaper CIT share classes may find that the cost difference between a mutual fund share class and a CIT share class is minimal or that the mutual fund is even cheaper.

Therefore, depending on the size of the plan in question, pursuing CITs may or may not make sense.

“With more than $19.5 trillion in assets, mutual funds are not going anywhere any time soon,” Barnett stated in the report. “As competition among investment vehicles ramps up, plenty of opportunities for mutual funds remain in the DC market. At the same time, asset managers that do not offer CITs as an investment vehicle must consider ways to materially lower expense ratios for their actively managed funds and specialty investment strategies to remain competitive.”