Increase seen in use of collective trusts in DC plans

CHICAGO — The seemingly endless quest for cost-effective alternative investments has increased the interest in collective trusts among employee benefit plan sponsors and financial advisers, though concern about transparency remains a hurdle. While collective trusts have been around for years, the Pension Protection Act of 2006 sanctioned the use of these funds in defined contribution plans. A collective trust is similar to a mutual fund but is an investment fund that is exempt from Securities and Exchange Commission registration and maintained instead by a bank or trust company for the collective investment of qualified retirement plans. The average monthly collective fund volume grew to $2 billion in the first quarter this year, from $500 million at the end of 2004, according to a recent white paper from AST Capital Trust Co. of Phoenix. The low cost of the funds appeals to plan sponsors who think that their employees can be diversified. Advisers said the returns from the trusts are similar to mutual fund returns. The cost for a mutual fund can be 1 percentage point, but for a collective-trust fund, it might be just 0.25 percentage points, said Chad Parks, founder and chief executive of The Online 401(k) in San Francisco. The company provides 401(k) services for more than 30,000 participants and 3,000 clients in all 50 states and has $333 million in assets under administration. However, even though collective trusts are less costly than mutual funds, their transparency is a sticking point for some in the industry. They aren’t regulated by the SEC and aren’t held to the same reporting standards as mutual funds. Nevertheless, Mr. Parks is considering using collective trusts, starting next year. “I like them because there is an opportunity to reduce fees. You still have good underlying assets, and [that keeps] performance where it needs to be relative to peers,” he said. However, Mr. Parks understands why plan sponsors should be concerned about regulatory issues. Collective trusts “are kind of like hedge funds,” Mr. Parks said. “They fall under a totally different area, and there’s been success and failures, too.” Harris Nydick, managing member of CFS Investment Advisory Services LLC of Totowa, N.J., also worries about the transparency of these funds, which would baffle the average participant, he said. “I’m not a fan of them for DC plans,” Mr. Nydick said. “I don’t know that they’re easily understood [by] the average participants.” Mr. Nydick said that he doesn’t plan to use collective trusts. CFS Investment Advisory Services manages about $500 million. Growing popularity But many are willing to write off the worries. Data from a white paper released July 16 by AST Capital Trust, a division of American Stock Transfer and Trust Co. in New York, showed that between 2003 and 2006, the demand for retail mutual funds in DC plans shrank to 54%, from 65%, but demand for collective funds rose to 41%, from 32%. Boston-based Financial Research Corp. said that collective trusts are expected to account for about 20% of all DC assets by 2011. Right now, they make up 18% of the assets. Major companies such as Burlington Northern Santa Fe Railway Co., Illinois Tool Works Inc., Southwestern Energy Co., Tasty Baking Co. and Time Warner Inc. offer collective trusts as an option on their 401(k) menus. Time Warner offers a dozen core funds in its 401(k) plan, and a few of those funds are collective trusts, according to Keith Cocozza, a company spokesman. The New York-based company wanted to provide variety for its employees, he said. Still, other industry leaders said, these funds are no different from mutual funds, except for not being regulated by the SEC. Chicago-based Morningstar Inc. tracks the funds, for instance. “In five years, I won’t even be using mutual funds,” said Keith Shadrick, president of Indianapolis-based Axia Advisory Corp., who has seen the number of clients with collective trusts increase recently. His plan sponsor clients can get excellent funds without the high costs associated with mutual funds, and that is due partly to the lack of regulation. Collective trusts are just as transparent as any other funds, Mr. Shadrick said. He works with plan sponsors in the midmarket and said that his average client has about $25 million in assets in their retirement plan. Axia has about $800 million in assets under management. The company manages five collective trusts worth about $150 million. It also has about an additional $200 million in collective trusts that it administers but are managed by other money managers. Harry Clark, president and chief executive of Clark Capital Management Group Inc. in Philadelphia, offers six collective trusts at his investment advisory company and said he thinks that the management of these funds is better than that of traditional mutual funds. “Our strategy is to keep an eye on these managers like hawks, and if they screw up, fire them and replace them,” he said. Clark Capital Management manages $2.2 billion. Of that, $50 million is in collective trusts. The company expects the collective trusts to grow to $500 million by the end of next year. Others have noticed the increasing popularity of collective trusts. “You can control your costs better, and they’re usually a cheaper option,” said Rick Meigs, president and founder of 401khelpcenter.com LLC in Portland, Ore. “A lot of the very large plans … were basically buying retail mutual funds,” he said. “So they started getting into collective trusts to reduce costs.” Advisers and money managers will need to begin to offer collective trusts so that they can maintain business, said Steve Deutsch, head of development for institutional-investment data at Morningstar. “Money managers are really trying to reposition themselves and want to find out how to offer these,” he said. “Their motivation is to ensure they don’t lose their market share.”