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CITs in 401ks: The Good, the Bad and the Ugly

March 22
11:06 2010

The New York Times recently ran a story that might interest the typical 401k plan fiduciary (“A Low Fee Option May Be Coming to a 401k Near You,” New York Times, March 16, 2010). Like many similar articles, this piece reads like the author 704670_95274685_hospital_cabin_stock_xchng_royalty_free_300has discovered a new-found panacea to all that ails the 401k fiduciary. The article offers this tantalizing lead: Collective Investment Trusts (CITs) have “been around for decades and they’re cheaper than mutual funds, yet few companies offer collective investment trusts in their 401(k) plans. But that seems to be changing.”

As luck would have it, I was personally involved in creating CITs in the early 1990s specifically to market to 401k plans. As usual, be careful about elixirs marketed as cure-alls. CITs, like any other investment products, have good, bad and ugly characteristics. I’ll share my experiences with you here:

The Good: The primary advantage of CITs to the bank (CITs can only be offered by Trust Companies) offering them is the lack of significant regulatory oversight compared to mutual funds. For example, while mutual funds fall under the jurisdiction of the Securities and Exchange Commission (SEC) and the rigorous rules of the Investment Company Act of 1940 (40 Act), CITs are monitored only by either federal or state banking authorities. In addition, while mutual funds must register with each state they’re offered in, CITs have no such requirement. This translates into a dramatic fee savings which the bank can either pocket or pass on to the 401k plan sponsor.

What’s more, since most banks don’t or can’t charge a trust fee directly to the CIT, all fees must be negotiated with each individual plan sponsor. This gives larger plans a lot of leverage to bargain for significantly lower fees. Indeed, most of the companies cited in the New York Times article happen to be very large. The Times quotes Morningstar data analyst Adam Baranowski, who says, “Mutual funds charge an average of 1.25 percent of assets, twice the average 0.63 fee level of collective trusts.” Of course, many plan sponsors – no matter what their size – currently use institutional fund shares, which can have expense ratios well below 1%, so the Times might not have told the whole truth.

The Bad: Smaller companies have much less leverage when negotiating. As a result, a bank will often charge a typical trust fee, which can range from 1% to 1.5%, much higher than the expense ratio of institutional class mutual fund shares. In addition, CITs don’t have the same public reporting requirements that mutual funds do (in fact, banks are prohibited from marketing CITs). As a result, the use of CITs may increase administrative costs. These cost increases shouldn’t offset cost reductions for larger plans, but they might eat into the perceived savings.

Similarly, the migration away from managed portfolios to mutual funds in the 401k market occurred because of the vast amount of publicly available data for mutual funds. Not only did this make life easier (and less costly) for recordkeepers, but it gave employees readily available data from multiple independent sources. As it stands today, any attempt to collect data on CITs (if it’s even legal) will suffer the same limits as similar attempts to collect data from individual investment advisers. Such universes tend to have a survivor bias, meaning, since disclosure will remain voluntary, only those CITs with better performance numbers will have an incentive to report.

Moreso, individual investors will find CITs won’t offer the flexibility of mutual funds. Not only will they find it hard to obtain good (and audited) independent data, they will also find they can’t rollover their money into the CIT upon leaving the plan.

Finally, in order to qualify as a CIT investor, the 401k plan must have a trust relationship with the bank. This can be a fairly innocuous relationship. However, I’ve seen many plan sponsors reluctant to enter into such a relationship.

The Ugly: Of course, for every Yin there’s a Yang. While avoiding the SEC and the 40 Act might lower costs, it also increases the risk to investors in CITs. Recall the original reason for the creation of the 40 Act: Many investors lost money during the 1929 crash because they had invested in bank CITs during the 1920s and those banks subsequently failed. Although trust companies separate trust assets from the bank’s balance sheet, the lack of regulation can often lead to unpleasant surprises. Just look at the concerns over hedge funds today. As CITs become more popular, there will no doubt be pressure to increase regulation (and increase costs) – but only after a spectacular failure.

In the end, CITs might seem a good solution for reducing fees, especially for very large plans. But, as usual, caveat emptor.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Keith Shadrick
    Keith Shadrick March 24, 17:14

    With all due respect, you are still living in the 90s and sound a little outdated in your information. I always enjoy your postings, but I think you’re off base on this.

    Many CITs trade on NSCC (defined contribution clearing platform) and just like mutual funds provide flexibilty and efficiency without any more costs than mutual funds when trading. There are no more in administrative costs unless the platform sees an opportunity to take advantage of the situation, which it sounds like what you have dealt with.

    Realistically, most investment managers are running model portfolios in their public funds, separate accounts and CITs. Is it really that important that Joe Sixpack see the underlying holdings. Remember, most 401(k) investors are not engaged and very passive with their approach to the management of their account. Is more detail about holdings really important? OK, they don’t have tickers and can’t pull them up on a website … is that really worth .50% (when quarterly fact sheets are available on the Plan website).

    Morningstar Direct provides a database of over 1,000 CITs … while it may not be the numbers of mutual funds, the information can be updated daily for CITs. CITs are audited on an annual basis just like mutual funds.

    Chris are you assuming the regulation by the SEC is going to catch an evil doer? Your alarmist attitude assumes that CITs are fly-by-night vehicles, they are not. CITs as a vehicle are not the problem, there are unscrupulous trustees or investment managers; just like there are there are unscrupulous mutual fund managers (market timing and boards)

    Being a “fiduciary” guy you failed to mention that CITs are fiduciaries to the plan – a big deal relative to mutual funds. I would have thought that distinction would have been a huge plus in the fiduciary realm you play.

    Here is the bottom line: I have used a five star mutual fund for years that has an OER in excess of 1%. I get the very same manager and portfolio (and a fiduciary to the plan) for .45%. My clients and their participants can live without being able to pull the ticker up on a website.

    I’m not sure there is any perfect vehicle in the market place, what I am sure is that cost matters and I prefer a fiduciary environment.

    ps. most mutual fund/investment managers prefer the consistent and stable cash flows of CITs versus the manic mutual fund flows in public funds. Data also suggest that is reflected in better returns.

  2. John Kutz
    John Kutz March 29, 09:27


    I am in agreement with the comments made by Keith Shadrick above. I am an Managing Director with an investment advisor who offers both mutual funds and CTFs to the defined contribution industry, so I believe that I am able to offer an unbaised view of the use of CTFs and mutual funds in defined contibution plans.

    In 2000, the NSCC added colleccive trust funds to the Fund/SERV system, allowing CTF transactions to be processed in the same automated fashion as mutual fund transactions. Transfer agents and trust adminstrators responded by upgrading their software platforms. This was a major step for CTFs, and it dramatically boosted their acceptance by retirement plan sponors. In 2003, CTF were used in approximately 32% of all defined contribution plans. By 2008, this figure had increased to 45%. During the same period, the use of institutional mutual funds grew by only 8% and use of retail mutual funds (A, R and C class shares) declined by 11%.

    CTFs aren’t just subject to oversight by federal or state banking agencies. They are also subject to review by the IRS, DOL and ERISA. National banks that offer CTFs are supervised by the Office of the Comptroller of the Currency (OCC). The OCC monitors adherence to Regulation 12 CFR 9.18(a)(2) which includes a written plan regarding the establishment of CTFs. The written plan (know as a declaration of trust) must include descriptions of: Investment powers and policies; allocation of income, profits and losses; fee and expenses charged to the fund and to participating accounts; terms and conditions govering admission and withdrawal of participating accounts; audits of particpating accounts; basis and method of valuing fund assets; income to be distributed to participating accounts (if any) and the expected frequency of distributions, minimum frequency for fund valuation, etc. The OCC is very thorough and does an excellent job in insuring that banks adhere to its written plan. In fact, the OCC’s oversight is on par if not superior to that of the SEC with mutual funds.

    The rise in CTF popularity is a result of two key plan fiduciary issues-fee transparency and plan cost. Unlike mutual funds, a plan sponsor must execute an Investment Management agreement with the bank who is offering the CTF. In that agreement, a full disclosure of fees and any revenue sharing with the third-party administrator financial advisor, ect. (if any) is clearly outlined. CTF fees versus both retail mutual funds and institutional mutual funds are lower most of the time. For example, for a plan that has total assets of $10 million in our Large Cap Core strategy, the net cost to the plan participant (fund expenses less any revenue sharing) in using the CTF strategy versus our instituitonal and retail mutual funds is as follows: CTF=55 bps; I Class Shares=68 bps and A Class Shares=82 bps. This 20% savings vs I Class Shares and 33% savings vs A Class Shares is passed on to the plan participant in the form of increased returns. As a plan fiduciary, plan sponsors have the duty to ensure fees are reasonable. For the Large Plan Market where plans are eligible for CTFs, I contend CTFs provide a real way to lower fees and help plan participants achieve their retirement objectives.

    It’s true that CFTs can’t be rolled over into an IRA rollover, but the plan participant can typically roll the assets into the A Class Share mutual fund “clone”. CTF performance information isn’t available on Yahoo, Morningstar and other third party data repositories like with mutual funds, but all recordkeepers update daily the NAVs of both the mutual funds and CTFs offered to plan participants. The recordkeepers also maintain historical performance information and post Fact Sheets for CTFs. In reality, if plan particpants are seeking CTF performance information, it’s as easy as going to the website provided by the plan sponsor and accessing the robust information warehoused by the recordkeeper. The notion that performance information isn’t “readily available” is merely an excuse to not use CTFs in plans. If this is such an issue, how have plan participants been getting performance information for the insurance separate accounts used in Group Annuity 401k plans?

    CFTs are alternatives to be used in the Large or Mega Plan market. It is our view that Retail and Instiutional mutual funds are suitable investment vehicles for the Micro, Small and MId Market Plan market. I’m not sure that it’s appropriate to use “Good, Bad and Ugly” when referring to CTFs (or mutual funds). Rather, it would be more valuable to outline the true differences in the product sets. I’d be happy to share our Collective Trust Fund Resoruce Guide with you or any reader that has an interest in learing more about CTFs and how to chose between CTFs and mutual funds. One product is truly NOT better than the other…just different.

    John Kutz

  3. Dennis West
    Dennis West March 30, 16:51

    John Kutz-

    Please forward your CTF Resource Guide. I have been a proponent of CTF’s, but was dismayed by prevailing bias amongst banks and trust providers towards mutual funds and separate accounts.

  4. John Kutz
    John Kutz May 24, 12:03


    Please send me your email address. I can be reached at


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