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An “Ex-CIT” (exit) from funding funds? Pension plans go to Collective Funding Trusts

We have seen an increase in the number of retirement plans recently leaving mutual funds in favor of mutual funds (CITs). Often times, the transition is simply a change in structure, that is, moving from the mutual fund of the same investment manager to its CIT counterpart. This post examines some of the possible reasons for this trend by comparing some key differences between the two mutual fund structures.

What’s under the hood

A mutual fund is generally a business trust that is registered as an investment company under the Investment Company Act of 1940 and is managed under a mutual fund offering document or “prospectus”. A mutual fund’s assets are typically held by a specialized bank or custodian; Shares in an investment fund are denominated in “shares”; and mutual funds are usually identified with a ticker symbol.

A CIT is established as a trust not registered under the Investment Company Act of 1940, with a trustee generally responsible for the administration and administration of the trust and its assets. The trustee may also appoint a sub-adviser to advise on the management of the trust’s assets, usually keeping final decision-making powers to himself. The trust is typically set up under a deed of trust and investors participate in the CIT by completing a subscription document containing the legal terms of the investment.

Who can buy

Mutual funds are generally available to all investors (although certain classes may only be available to certain investors who meet certain minimum requirements or other qualifications). CITs may need to restrict eligible investors based on whether a CIT intends to qualify as an exempt group trust under IRS Revenue Ruling 81-100 (which many do) and depending on securities law exemptions from which the CIT want to leave. The effect of these rules is that CIT participation is generally limited to various types of retirement plans and schemes.

Who is the ERISA trustee here?

A key difference between mutual funds and CITs is the applicability of ERISA. Investment managers and mutual fund sponsors are exempt from ERISA because the mutual fund’s shares held in the plan’s trust are “plan assets,” but the mutual fund’s underlying assets are not. In contrast, if there is only a single ERISA plan investor in a CIT, the underlying assets of the CIT are plan assets, which are subject to all of ERISA’s fiduciary and prohibited transaction regulations.

Show me the money

One of the main reasons a trustee decides to swap a mutual fund for a CIT is cost. CITs can often offer the same strategy at a lower cost by avoiding the additional costs associated with the regulatory regime that applies to mutual funds. Of course, the move would mean that regulatory protection for mutual funds would not be automatic, but that the trustee may have to negotiate more protection terms for the investment.

CITs are also usually more flexible than mutual funds to quickly and easily establish new asset classes with different fee levels, which gives CITs more leeway in negotiating fees in order to attract investors with different investment amounts. While CITs generally offer fee and cost savings, plan trustees should consider other expenses in implementing the CIT, such as more extensive legal review and participant communications.

Moving to lower-cost investment options can also offer trustees some convenience, given the explosion in ERISA litigation we’ve seen in recent years, with many cases claiming trustees choosing planned investment options that were too costly.

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