lineup options in the defined contribution (DC) plan landscape have not changed
much over the years. Mutual funds have long been the dominant investment choice
and continue to be, at least in the small- to mid-size plan market. But there
are other options that sponsors have begun looking to in order to shake up
not a lack of alternatives to mutual funds that is at play. In a 2012
PLANADVISOR survey shows a significant percentage of providers offer collective
trusts, managed accounts, and exchange traded funds (ETFs) as investment
options. Even though a small number of plan sponsors have made changes to
include some of these options, there is an uptick in the number of sponsors who
are considering other investment structures for their plans.
the years, larger plans led the way in exploring alternative investment
structures for their plans. As plans grew, sponsors began using lower-priced
institutional funds in order to provide the lowest cost fund for participants.
This process has migrated down-market where plan sponsors of all sizes are
trying to provide the lowest-cost share class their recordkeeper will accept.
This has opened the door to consider other investment structures such as ETFs, collective trusts, separately managed accounts (SMAs) and other
Despite initially being championed as an inexpensive alternative to mutual funds, ETFs not found their way into significant numbers of retirements. According to the 2012 PLANSPONSOR DC Survey, just 0.9% of plans offer ETFs as an investment option to their participants, although the 2012 PLANADVISER Recordkeeping Survey shows that 38% of providers offer ETFs.
The most obvious reason to consider exchange-traded funds is lower fees. ETF expense ratios are generally lower, relative to comparable mutual funds. That lower-fee advantage, however, may not hold for larger plans that can still obtain lower fees by using investment classes of mutual funds with large asset pools.
On the negative side, experts say, ETFs trade intraday, and most defined contribution (DC) plan platforms can handle only investment options that trade at day’s end—the way mutual funds do. Thus, to add ETFs, sponsors may need to switch from their current recordkeeper to one that can handle these funds.
most common investment structure in retirement plans, after mutual funds, is collective
trusts The main reason for the popularity, besides costis that collective
trusts have been in existence for a long time, so the product is familiar. Yet,
collective trusts are still fairly uncommon with just 13.2% of plans offering
collective trusts. This is despite the 2012 PLANADVISER Recordkeeping Survey showing
that 85.9% of providers offer collective trusts.
is the beginning of a trend in assets moving from mutual funds to collective
trusts, due to a combination of more product availability and 408(b)(2) fee
disclosure requirements. 408(b)(2) fee disclosure requirements has helped plan sponsors
open up conversations about them.
while reducing fees is the main driver of interest in collective trusts, the
fee differential varies widely. Some collective trusts are significantly less
expensive than their mutual fund counterparts. Others are roughly equivalent,
and, for midmarket plans, institutional share classes of mutual funds may be
the less expensive options. This is partly because, when entering an existing
collective trust, a set fee schedule is usually in place, and only customized
collective trusts sold to larger plans typically let their fees be negotiated.
Separately Managed Accounts
Separately managed accounts are also a less
significant portion of the industry because because of the sheer asset size
required to create this type of alternative investment. Generally, only the
largest plans use separately managed accounts.
Separately managed accounts provide more
visibility into underlying holdings providing more detail for participants.
SMAs basically unbundle the strategy so that you see the underlying equities as
The investment clarity of SMAs is popular among plans with
professionals such as accountants, physicians, engineers.
evaluating investment structures for plans, advisers should consider the
- Assets Under Management. Advisors need to look at assets under
management (AUM) in any vehicle they consider recommending. A firm may have a
mutual fund with hundreds of millions of dollars and a collective trust with
just $10 million. Smaller funds tend to be more expensive because there are
fewer parties among which to split fixed expenses, such as auditing fees.
- Recordkeeper Availability: Advisers should review the availability of
investment alternatives available on the recordkeeping platform and become
familiar with any changes in process that may result by adding the investments.
- Daily Valuation. Daily valuation is critical for all 401(k)
investment options. Plan participants are used to seeing their account balances
as of the prior closing price.
- Plan Demographics. Advisors should know about the participants
and the plan sponsor before recommending an investment alternative. An
evaluation should be made about sponsors and participants and how comfortable they
are with mutual funds relative to ETFs, collective trusts or separately managed
- Participant Communication. If an advisor recommends a commingled fund or
other less-common vehicle, he may need to make sure the investment manager will
provide basic information about the fund to the recordkeeper so the latter can
pass that on to participants. The money manager needs support providing information
to the participant who wants to invest in the fund.
- Understanding Fees. What does it cost? Cost has always been a big factor in retirement plan
investment selection and a clear understanding of the investment expense should
be presented. New 408(b)(2) rules require that overall selection of a structure
will be driven by total fees and include disclosure of revenue-share