Archive for category Practice Management
Expert Says Delaware and South Dakota Trust Providers Should Boost Fees
Posted by Scott Martin in Practice Management on June 5th, 2010
Pricing guru Rafi Mohammed recommends providers in trust-friendly states charge higher fees for services not available elsewhere.
Trust companies in a position to provide a broader range of products don’t need to cut prices to compete and are even justified in charging higher fees, says Rafi Mohammed Ph.D, a leading pricing expert and author of books like The 1% Windfall and The Art of Pricing.
“If I come to you and say my trust product can avoid taxes for generations to come while others don’t, your eyes would be popping,” he told me. “If consumers are really hooked on the dynasty trust, then vendors should not be afraid to ask for a top-dollar premium on that added value.”
To earn that premium, out-of-state trust companies have to give prospective customers a good reason to move their business out of the local market. In some jurisdictions, the selling point might be the perpetual or “dynasty” trust, which potentially lets beneficiaries avoid generation-skipping taxes for centuries. Or it may be the self-settled asset protection trust, which is designed to shield wealth from litigators.
“This is not a mass-market product,” Mohammed told me. “Articulate how you are different and how it benefits the consumer,” he added. “Especially in high-net-worth markets like this, it’s not always about the best price.”
Some value propositions are easy to demonstrate to a prospective client. Just moving a plain vanilla trust from New York to Nevada, for example, improves its real investment performance by about 113 basis points a year simply by eliminating drag from state taxes.
That’s a huge added value, and trust companies in tax-free states can get a few of those basis points for themselves if they can communicate what those basis points add up to over the decades.
Competing on value, not price
As long as a trust company avoids charging a lot more than rivals that offer comparable value, it should definitely forget about charging less in order to win business, Mohammed says. After all, these are multi-million-dollar trusts, not Volkswagens.
“Your marketing should never be about a race to the bottom,” he told me. “Once you establish that your offering is competitive with what direct competitors are charging, there’s no reason to lower your prices. People are always too quick to lower prices.”
If your offering isn’t competitive in a particular market, don’t compete there. Directed trust companies like Santa Fe Trust or Georgia-based Reliance Trust often operate in states that don’t support some forms of trusts, so they have to refer these accounts to other vendors—and don’t spend much time chasing them.
“Perpetual trust can be an issue,” Santa Fe CEO Kathy Roberts told me recently. “We can provide those services through partnerships in other states, but the advisors we work with are more interested in arrangements that are easier to administer right here.”
The numbers speak for themselves
After Delaware changed its statutes to allow perpetual trusts, trust companies operating in the state doubled their assets in five years as money flowed in from all over the country. Clearly, the trust-friendly environment was good for business.
Harvard law professor Robert Sitkoff has been looking at this issue for years alongside Max Schanzenbach at Northwestern. Not all of the 20 perpetual trust states were created equal, he tells me.
In fact, according to their research, between 1995 and 2003, one out of every ten trust dollars—$100 billion—moved to jurisdictions that, like Delaware, South Dakota and Nevada, support trusts in perpetuity but do not tax out-of-state accounts.
States like Wisconsin, which allow perpetual trusts but tax the assets, didn’t get many of those accounts.
“Once there’s a reason to go out of state to take advantage of more favorable statutes, picking the one with the best tax treatment is an obvious decision for an estate planner to make,” Sitkoff explains. “The added cost is minimal and the benefits are huge,” he added.
Other competitive propositions seem harder to sell. Sitkoff and Schanzenbach have yet to find any proof that asset protection, spendthrift trusts, added confidentiality or other added services have translated into concrete asset flows.
“We’re just not picking any of that up,” Sitkoff says.
Pricing and profitability
Some of the most trust-friendly states provide trust companies with a two-pronged benefit: premium service and better margins.
While Philadelphia-based Sterling Trustees is setting up its trust operation in South Dakota because it likes the regulatory climate, Antony Joffe, the company’s president, tells me cost efficiencies are a nice bonus.
“We can operate more cheaply than the Glenmedes and Wilmingtons of the world,” he says.
Rafi Mohammed says that trust companies that operate in low-cost states like New Mexico or South Dakota offer the same level of service as rivals in high-cost states like Pennsylvania or Delaware, so they should charge the same fees.
“There’s no need to lower your price to pass on your efficiencies to the client,” he advises. “When consumers evaluate your product, they never say ‘The most I’m going to pay is double costs,’” he added. “Your profits should never be part of the conversation,” he added.
Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing
Permalink: http://thetrustadvisor.com/practice-management/value
Using Influencers to Land New Trust Accounts
Posted by Scott Martin in Practice Management on May 30th, 2010
Many trust companies have more success marketing their services to the professionals who already have the ear of wealthy clients. Lawyers, investment advisors, accountants, even art appraisers are all worth adding to your network.
Plenty of trust companies are gathering assets by targeting the professional advisors who steer high-net-worth clients toward trusts in the first place.
Accountants, lawyers and other advisors rarely have the power to decide where a client opens a trust account, but they do have an enormous influence on the choice, says analyst Robert Testa, who covers the private wealth management industry for Cerulli Associates.
“Especially for trust companies, we’ve found these reciprocal relationships with other professionals are the most effective way to gain clients,” he told me.
Think of these professionals as the Oprah Winfreys of the wealth management world. Oprah doesn’t actually sell books, but one plug from her helps millions of potential book buyers make up their minds.
The relationship between estate planner and client works a lot like this, Testa says. When a lawyer or financial planner realizes that it’s time to move assets into a trust, the client rarely has a strong opinion on which trust company to go with. Instead, what the planner usually hears is, “What do you suggest?”
Being the answer to that magic question has translated into new business for 68% of the bank trust departments that Testa’s team polled last year, and independent trust service providers would be well served to follow suit.
It’s all about relationships
Estate planners are an obvious fit because they are at ground zero whenever a wealthy family decides to set up a new trust or modify an old one.
However, if you want to get the real inside track on how potential clients’ financial situations are changing, get friendly with their accountants, Testa says.
“You would think people would be more honest with the trust officer or the asset manager, but the CPA knows everything,” he explains. “Once you get a close relationship with the CPA, you can gather the assets.”
Corporate entitities can wield influence too. Millennium Trust got a substantial profile boost this spring when Schwab Advisor Services pointed it out to its 6,000 advisors as a custodian for alternative assets that were no longer welcome on the Schwab platform.
“What we’re able to do is go after the advisor market,” Mary Hackbarth, who heads up Millennium’s marketing, told me. “In terms of business strategy, working with advisors as centers of influence has worked out.”
Even an influential brand goes a long way. When the Dow Jones news service wrote up trust consulting firm Advisors Institutional Services, its marketing team was quick to license reprints that paired the story with the venerable Wall Street Journal logo. While it isn’t an endorsement, the logo still has a positive influence on prospective clients.
Anyone in a position to weigh in on the decision-making process is a potential referral source. Real estate brokers and insurance agents are worth adding to your professional network because they’re often on the scene when people make pivotal life decisions or come into significant wealth.
Robert Testa also recommends cultivating more esoteric professionals on the off chance that they’ll have the right ear at the right time.
“We’ve even heard that the art valuation experts at UBS have referred their clients toward trust companies,” he tells me.
Double-edged sword
Naturally, financial planners and other registered investment advisors are a time-honored center of influence. Jocelyn Schwartz, who ran Fidelity’s estate planning business and is now a financial planner at Pillar Financial Advisors, is often in a position to direct new business to trust companies and the lawyers who write up trust agreements.
She’s also used her influence to move accounts from legacy providers.
“We do spend a lot of time reviewing existing trusts,” she told me. “Disrupting the apple cart is not our first goal, but sometimes we get a client who just isn’t happy no matter what the trustee does, and then that money has to move.”
While Schwartz is happy to work with trust companies that won’t let Pillar manage the underlying assets, other wealth managers are wary of referring their clients to a potential competitor.
“They’re afraid that giving a Wilmington or a Glenmede custody of the assets means the next call their clients get will be from a Wilmington or Glenmede investment advisor,” says Antony Joffe, whose new public trust company Sterling Trustees plans to aggressively market to lawyers and accountants as well as RIAs.
Some trust companies get around this potential conflict of interest by only working with directed trusts and other arrangements that kick the investment responsibilities (and fees) back to the referring advisor. Sterling doesn’t quite do this—Joffe reserves the fiduciary right to fire managers even if they brought in the account in the first place—but plenty of other direct-trust-only providers do.
“We don’t compete with the intermediaries,” Reggie Karas, who runs Millennium Trust’s alternative asset business, told me. “We’re a very plain vanilla service provider by design so we can better build our business in partnership with them,” she added.
In fact, a really successful influencing relationship is always going to be a two-way street, Robert Testa says. Trust companies get the accounts, while influencers get the opportunity to prove their value as a one-stop source for all their clients’ needs—and sometimes even get prospects of their own passed back along the chain.
“Reciprocity is crucial,” he told me. “A trust company with a preferred relationship with an estate planner can suggest that person when trust documents need to be modified,” he added.
“A lot of clients who are missing a piece of their own professional advice network are at a loss. A suggestion goes a long way to getting the best outcome for everyone.”
Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing
Permalink: http://thetrustadvisor.com/news/influencers
Westwood Trust’s “Common Trust Funds” Emerge as Bellwether Business Model for Advisors
Posted by Jerry Cooper in News, Practice Management on January 22nd, 2010
Exclusive
CEO says new funds can be started in minutes, not months, at a fraction of the cost of a mutual fund.
Earlier this month The Trust Advisor reported Westwood Holdings Group, Inc. (NYSE: WHG), through its trust company unit Westwood Trust, helped forge gains by landing large new accounts while other firms sat on the sidelines. Westwood managed to bring in $2 billion in new assets during the toughest year in recent financial memory.
As part two of our report on Westwood Trust, I had an opportunity to chat once again with Brian Casey, President and CEO of Westwood, to drill down into the topic of interest to most wealth advisors – common trust funds.
New Money from an Old Idea
Simply stated, common trust funds or “CTFs” permit the commingling or pooling of investors’ money into one account (known as a common fund) for the purpose of creating a single investment. In other words, they are much like a mutual fund. They actually pre-date mutual funds so they are an old concept. Since they are a bank product, CTFs are not required to be registered with the Securities and Exchange Commission and they are not considered to be a security under state and federal securities laws. They are regulated under OCC Regulation 9 (12 CFR 9.18) and are supervised by state or federal bank regulators.
Casey says there are two types of CTFs. The first are common trust funds or CTFs, a product of a bank or trust company established as a convenience to the trust client. The second are collective investment funds or CIFs. These are utilized primarily by large qualified plan sponsors who are seeking institutional pricing for a large pool of retirement assets such as 401ks. They strike an NAV daily and trade on Fundserve. Casey adds, “We actually have one of these that we developed for a Fortune 100 company 401k plan and the data is available in Morningstar.”
But Westwood’s power products are the CTFs, common trust funds. They are private and only available to clients of Westwood Trust. Casey says that “they are only available to our clients who have a bona fide personal trust relationship with the trust company.” Their minimum account size is $2 million which can be either a taxable or retirement account. But, in other words, to benefit “you have to be a trust client and have seven figures with us to be part of the club.”
According to the Westwood’s 10K quarterly report for the year ending September 30, 2009, $1.4 billion of its $9.5 billion or 15% of its assets under management are held in common trust fund relationships.
The Strategies
Westwood runs 31 separate common trust funds which are based on 15 asset classes. Casey adds, “With institutional quality and thoughtful asset allocation, the client is given a better shot of achieving what it is that they’re trying to do than picking a mutual fund off a list.”
To the client, “expenses matter.” With a CTF the only charge is a management fee. There is no legal, accounting, transfer agent or fund supermarket fees that are normally part of a mutual fund fee structure.
Westwood offers five different “flavors” of value. This includes small-cap, all-cap, large-cap , mid‑cap and smid-cap value. As for income, they offer five types of income products including investment grade bonds, REITs, High Yield and two unique income funds.
They have an esoteric type of fund called the Income Opportunity Fund. This allows them to participate in a company through different parts of its capital structure. This might include, for example, a high dividend paying common stock, a preferred stock, or part of a company’s debt in the form of a bond. Or, they might own royalty trusts or MLPs.
They just started a popular Global Diversification Fund CTF. The strategy on this vehicle is to focus on investor purchasing power protection. Casey remarks, “As U.S. citizens, we have a lot of obstacles that could diminish the purchasing power of our savings, like inflation or the potential decline of the U.S. dollar.” This fund might hold global TIPs or treasury inflation protected securities, global bonds, gold, and other types of commodities.
While Westwood manages all of the domestic value and income funds, Westwood employs outside subadvisors chosen by Westwood’s investment committee with assistance from an outside consulting firm. To manage the domestic growth funds, Westwood uses William Blair in Chicago as their subadvisor.
For International Value, Westwood uses Lazard based in London and for International Growth, Westwood employs Martin Currie based in Scotland. The fees paid to subadvisors come out of Westwood’s pocket as opposed to any additional fee to the client. Casey says, “Asset allocation is critical to long-term investment success.”
Westwood is a world-class investor in the value and income space, but we recognize that investors need access to both domestic and international strategies to complete their asset allocation plan. We have a talented consultant on retainer and an experienced investment committee to help us identify best in class subadvisors.”
Technical Items
A major part of hosting a selection of common trust funds servicing close to $1.5 billion is the technology platform. The two major factors that must be considered for any common trust fund trust accounting systems are (1) to keep track of each investors holding and (2) to be able to strike a daily NAV calculation for each fund.
Westwood uses a trust accounting system called Infovisa. Casey said they have been working with Infovisa for over 10 years and they deliver a “great system.” He remarked that the folks that started Infovisa came out of SunGard.
SunGard offers two trust accounting systems to support CTF processing. The two systems are: Charlotte, which is utilized primarily by firms with zero to US$2 billion in trust assets. Customers include smaller community banks and private trust companies as well as startup firms. The other is AddVantage, which is typically used by large regional and national banks, with no theoretical size maximum in terms of assets, transactions, or users.
Each of the systems has been designed to work in conjunction with SunGard’s wealth management platform solution, Wealth Station. The trust platforms are also able to utilize the trade execution and compliance tools of the SunGard Transaction Network (STN).
Advent also offers a common trust fund system. It is actually a mutual fund system, but may be used to keep track of CTFs.
Taking Action
Common trust fund arrangements offer clients lower fees than mutual funds. That together with the enormous flexibility to create a pooled investment vehicle in minutes means that CTFs are likely to become an important part of the investment landscape.
The ease with which a trust company can be established in South Dakota, Nevada or Delaware by investment managers, has made inroads to this field, establishing a kind of “turnkey” service, which allows investment managers and plan administrators to easily establish new common trust funds arrangements.
Advisors Institutional Services (www.advisorsinstitutional.com), which I support, helps wealth managers, advisors, broker-dealers, law firms, and pension plan administrators create and operate trust companies in South Dakota and Nevada. This can permit an advisor to replicate the Westwood Trust business model.
The firm offers a complimentary special report called Launching a South Dakota Trust Company Guide to Operating Nationwide which is available on-line at (www.advisorsinstitutional.com/s/southdakotareports.asp).
Jerry Cooper, senior editor, The Trust Advisor Blog. Steven Maimes contributed to the research.
America’s Most Wealth Friendly States Continue to Bid for Your Clients’ Trust Business
Posted by Jerry Cooper in News, Practice Management on January 15th, 2010
State legislatures are still enacting trust law enhancements to provide greater protection for your client’s wealth.
As more wealthy families cross borders to protect assets, they choose to set up personal trusts in states other than their own to take advantage of favorable trust laws.
According to recent data, 72 percent of U.S. households with more than $1 million in investment assets use trusts as a key component to their estate planning.
The main reasons to cross borders are:
• Some states don’t tax assets held in a trust, while distributions might be taxable in your home state.
• Trust codes in some states seek to protect assets from lawsuits and creditors.
• Some states allow “dynasty trusts” which permit future generations to avoid estate taxes.
Over the last few years a growing number of states have revised their trust codes to add features that provide for creditor protection, low or no state income tax and ability to establish a dynasty trust which allows for assets to pass to heirs for generations to come.
Nevada recently revised its trust code to provide for directed trusts. Directed trust statutes provide for an ability for the trustee to appoint an investment advisor to manage assets within the trust. This provides for low trustee fees and minimal trustee liability and provides flexibility to the investment manager ultimately benefiting the client.
Steven J. Oshins, an estate planning attorney and author of several trust laws in Nevada says, “Nevada’s new directed trust statute is critical to high net worth investors.” He adds, “Nevada now offers everything Delaware offers and more because of the combination of its 365-year dynasty trust law, two-year statute of limitations on self settled asset protection trusts and no taxation.”
Alaska revised its trust code to make it more difficult for divorcing spouses to grab trust assets. State trust laws vary widely and clients should compare jurisdictions for features that best fits their needs. Some of the most important trust features include whether or not a state has income tax.
When setting up a trust arrangement having a trust in a state that has no income tax has a definite economic financial impact on your client’s family. Therefore, no state income tax is amongst the most important.
Dynasty trusts are important beginning next year when estate taxes resume at a 55 percent tax rate. The general rule is the longer the period of time that the trust can exist the better it is.
Other factors include the number of trust providers or independent trust companies in the state which is an indication of whether a trust center is beneficial to a client and the time zone from New York.
But going out of state for a trust may not always make financial sense, especially for smaller trust accounts. Since the most favorable jurisdictions might be in states where you don’t know an individual trustee, you might need to hire a corporate trustee, which can cost about between ½ of 1 % to 1% or less of trust assets per year, depending on the size of the trust.
Moving an existing trust may also involve additional fees and may require court approval, depending on how the trust was originally drafted and state law.
With great states spread around the country, one important factor to consider when seeking a home for a trust is the avoidance of state income taxes. Trust experts say one of the first factors to look for when examining where to set up a trust is whether the assets are subject to state taxes.
The idea is to let trust investments grow for as long as possible free of state taxes, which can save significant sums of money, especially in high-tax states such as New York and California. (Beneficiaries, however, may be taxed on distributions, depending on whether their home state has an income tax.) Alaska, Delaware, Florida, Nevada, South Dakota, and Wyoming are attractive because they don’t impose any taxes on trust assets.
The following chart, the Best States for Trusts gives you a thumbnail view of which states are best. It is divided into three tiers Tier 1 being the best, Tier 2 being good and Tier 3 being marginal. Given that Alaska, Delaware, Nevada, South Dakota are in Tier 1 they are probably your best choices for trust business.
|
The Best States for Trusts |
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|
Tier |
State* |
State Income Tax |
Directed Trust Statute |
Asset Protection Trust |
Dynasty Trust Ability |
Number of Trust Cos. |
Time Zone (from NY) |
|
1 |
No |
Yes |
Yes |
1000 yrs. |
3 |
(-) 4 |
|
|
1 |
Residents |
Yes |
Yes |
Perpetual |
32 |
(-) 0 |
|
|
1 |
No |
Yes |
Yes |
365 yrs. |
26 |
(-) 3 |
|
|
1 |
No |
Yes |
Yes |
Perpetual |
39 |
(-) 1 / 2 |
|
|
2 |
No |
Yes |
No |
360 yrs. |
9 |
(-) 0 |
|
|
2 |
Residents |
Yes |
Yes |
Perpetual |
19 |
(-) 0 |
|
|
2 |
No |
Yes |
Yes |
1000 yrs. |
2 |
(-) 2 |
|
|
3 |
Yes |
Yes |
Yes |
1000 yrs. |
7 |
(-) 2 |
|
|
3 |
Yes |
No |
No |
Perpetual |
3 |
(-) 2 |
|
|
3 |
Residents |
No |
No |
Perpetual |
2 |
(-) 0 |
|
|
3 |
Yes |
No |
Yes |
1000 yrs. |
2 |
(-) 2 |
|
|
3 |
Residents |
No |
No |
Perpetual |
4 |
(-) 1 |
|
|
*States: links to State Trust Statutes Data: January 2010 |
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© 2010 TheTrustAdvisor.com (781) 319-7748 |
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States bidding for trust business often will not tax those assets they are betting on increased economic activity which will bring other prosperity to the state such as job creation, corporate tax revenue collected from trust companies, corporate tax assessments from the trust companies.
It is for this reason that state legislatures continue to sharpen their pencils and enact new laws designed to attract wealthy baby boomers and their parents’ estates for future generations. Trust accounts have been an important port of the investment landscape.
For wealth management organizations advisors can gain additional income and provide more value to their service by bundling trust services within investment management. Last year several advisory firms launched their own trust companies in order to be better positioned to provide these services.
This includes Wealth Advisors Trust Company and Dominion Trust Company in South Dakota, both new launches targeting wealthy clients from a wealth-friendly trust state. This trend was featured in an Investment News Article last summer, More Advisory Firms Expected to Start Trust Companies.
Trusts can be created for a variety of other purposes including avoiding probate, passing on a family home to heirs, protecting money from creditors, caring for disabled child or even providing for a pet after one dies. Trusts continue to grow in popularity thanks to the aging population and more aggressive trust marketing by financial firms and the concerns about maximizing trusts’ growth performance.
Asset protection trusts have gained in popularity as marketing vehicles for advisors over the last several years with Alaska, Delaware, Nevada and South Dakota being the most popular jurisdictions. Doctors, business executives and other professionals have become increasingly interested in these trusts, advisors say. With these you transfer assets into a trust run by an independent trustee who can give your client distributions from time to time. These trusts if set up properly are in most cases able to keep the assets of the trust out of reach of creditors.
Jerry Cooper, senior editor, The Trust Advisor Blog.
Story Permalink: http://thetrustadvisor.com/news/states
Collective Investment Funds Re-emerge as Mainstream Investment Option
Posted by Jerry Cooper in Practice Management on December 11th, 2009
Why the comeback? A demand for lower expenses and more flexibility make qualified plans a major market
Collective investment funds, sometimes referred to as common trust funds, are not a new investment structure in the U.S. market. In fact, they have been available in the market for decades, to both defined-benefit and defined-contribution plans.
In the past, however, collective investment funds had also always been perceived as a bank product, and mutual fund companies were, for several decades, the growth leaders in the retirement plan arena. As 401(k) plans began to grow quickly in the 1980s, they found mutual funds an easy-to-use product, further slowing the development of collective investment funds.
Now, collective investment funds are making a very strong comeback for several reasons.
The primary factor in the last few years has been faster computers and better communication networks. These have allowed collective investment funds to be priced and traded on a daily basis.
Collective investment funds are remarkably similar to the mutual funds many of us are familiar with in the marketplace; they can invest in equities, fixed income, ETFs and even mutual funds.
Additionally, they can create custom asset allocation portfolios to meet the needs of a particular client. This feature has been extensively used by pension plans that desire the collective investment funds to be utilized as a life-cycle fund.
While many pension plan sponsors had shied away from including collective investment funds in their employees’ plans in the past, there are now more than 1000 collective investment funds available, and that number keeps growing.
Many of the collective investment funds available today are near mirror images of mutual funds that asset managers already offer to pension plans.
In fact, some of the stable value funds already available are so identical to the mutual funds they mirror that many plan participants are unaware of the transition from mutual fund to collective investment trust.
There are a few key differences, however, which make them remarkably well suited for use within 401(k) retirement plans.
The Market
There are several factors which make CIFs different from mutual funds. Nearly all of them are helping drive more and more business toward the collective investment trust market. While collective investment funds have been available to institutional investors and large pension funds for decades, they have gained increased popularity as of late for a number of reasons.
Long the domain of private equity and hedge funds, mainstream mandates are being increasingly found in non-registered products. Investment managers that have traditionally offered registered funds (mutual funds) are showing considerable interest in non-Securities Exchange Commission (SEC) registered vehicles as of late, such as collective investment funds. Investment managers are looking to commingle separately managed accounts to save on operational costs, and roll them into collective investment funds.
Investment managers have realized that the growing collective investment trust market can provide them with access to new markets, lessen their cost burdens related to increasingly complex regulations, give them a faster time to market, and decrease their costs. This has resulted in collective investment funds being found in most pension plans in the United States.
The ability of mutual funds to be offered to a wide variety of investors, from institutional to retail, means that they have assets coming in from a wide variety of distribution channels.
When compared to collective investment funds, this proves to be a disadvantage for the mutual funds, as the necessary record-keeping, tracking, trading and fee allocation add an enormous burden to the mutual fund firms and their custodians. Collective investment trusts, offered exclusively to institutional investors, are able to avoid this added burden.
Regulatory Changes
The Pension Protection Act (PPA) of 2006 created a big boost for CIFs. The PPA strongly encourages companies to set up automatic enrollment for their employees into default investment plans, referred to as “Qualified Default Investment Alternatives” (QDIA).
These can be balanced accounts, target-date (life-cycle) funds, or managed accounts. Many employers are scrambling to comply with the PPA, and are setting up new 401(k)s, or setting up automatic enrollment plans for their employees to contribute to their pre-existing 401(k) plans.
However, while one aspect of the PPA has driven employers to set up automatic enrollment plans (helping mutual funds, ETFs and collective investment funds), there is another aspect of the PPA that has driven business specifically toward collective investment funds: That is the requirement for plan sponsors to act in the interest of their participants and seek out low-cost options to be included within their 401(k)s.
This has spurred the trend toward low-cost investment solutions in order for employers to protect themselves from a fiduciary point of view.
• The Department of Labor (DOL) has also debated the possibility of including target-date and target-risk collective investment funds within its selection of acceptable default investments in pensions, under the PPA.
• The Government Accountability Office (GAO) has also conducted an investigation into the fees being charged in 401(k) plans, further driving plan sponsors away from mutual funds and toward lower cost alternatives.
• Collective investment funds are not regulated by the Securities and Exchange Commission, and are exempt from Section 3(c) (11) of the Investment Company Act of 1940 (more commonly referred to as the “40 Act”). While this may appear to be a minor difference between collective investment funds and mutual funds at the surface, this is a key factor, which affects the attractiveness of collective investment trusts to 401(k) plans greatly. The reason for this is that collective investment trusts, being exempt from oversight by the SEC, are not required to adhere to the strict regulations imposed by the 40 Act. These regulations stipulate, among other things, that mutual funds provide prospectuses to potential investors and provide regular written reports on the status of the fund.
Regulation of CIFs
Instead of being regulated by the SEC, collective investment funds fall under the auspices of the government’s Office of the Comptroller of the Currency, which is part of the U.S. Treasury Department. The ability of the collective investment trust not to be burdened by the cumbersome requirements imposed by the SEC — as well as by the enormous amount of expenses associated with the production and printing of prospectuses and reports — already helps to make collective investment funds more attractive to pension plans.
Yet, their not being regulated under the 1940 Act shuts collective investment funds out of the 403(b) plan market, as 403(b) plans stipulate that only funds which fall under the 1940 Act be included in their offerings. Unfortunately for collective investment funds, this has locked them out of many teacher and non-profit pension plans, and there does not seem to be any legislation on the horizon to remedy this.
Requirements For CIFs
Collective investment trusts are required to be valued at least once every three months (although, realistically, most collective investment funds are now valued at least monthly, and many much more frequently). There is an exception to this rule: collective investment funds which are primarily invested in real estate or other assets and which are not readily marketable (in these cases, the collective investment trust should be valued at least once a year).
Also, at least once during each 12-month period, a savings association administering the collective investment trust must arrange for an audit of the collective investment trust, and the collective investment trust must also provide a report summarizing security purchases (with their costs), a summary of sales (with profit and loss and any other investment changes), income and disbursements, and an appropriate notation of any investments in default.
Collective investment funds are not allowed to be sold directly to retail investors, as they are not regulated by the SEC. Instead, they are only saleable to institutional investors, and are generally sold into Defined Benefit and Defined Contribution plans.
Because they are not sold directly to retail investors, not only do collective investment funds avoid the costs of printing materials such as prospectuses, but they are not burdened by expensive administrative, advertising and marketing costs. Collective investment trusts also avoid the cost and rigmarole of supporting toll-free telephone service centers and dealing with retail investor inquiries.
In lieu of a prospectus, a collective investment fund is able to issue a much shorter and simpler “disclosure statement” to investors. Collective investment trusts must also file a trust document with the IRS for a determination letter, and also must file a form 5500 annually. Collective investment funds do not issue proxies, helping to further reduce their cost.
Another factor to bear in mind when dealing with collective investment funds is that they must be held and offered by a bank or trust company (generally a bank or custodian). Technically, it is the bank or custodian that is the trustee of the collective investment trust. If, in theory, the selected asset manager were to not perform their duties, they could be replaced by another manager.
CIF ETFs
There has also been a group of collective investment funds designed around holding only ETFs as the underlying portfolio. Not only does this provide a cost savings of approximately 60 to 80 basis points per collective investment trust, but it also provides a much greater diversification for the portfolio. The individual ETFs are combined to build an investment strategy in the same fashion that stocks or bonds would be in a traditional collective investment trust.
The difficulty is that the selection of ETFs is rather limited, with a much more finite number of ETFs than individual securities. Despite their limited number, ETFs have more than US$400 billion in assets under management in the United States alone. Even so, ETFs can present their own set of technological issues in regard to their pricing. The transaction costs associated with weekly automatic contributions or from active trading have the possibility of negating any cost savings to be gained from lower expense ratios.
Some custodians have had difficulties in addressing the needs of ETF managers who require much more rapid delivery of real-time or near-real-time information.
Also, many 401(k)s using ETFs are looking to bundle trades, in order to spread transaction costs across multiple users, which presents further technical issues (especially involving record-keeping). ETFs will still have a difficult time being fully accepted by 401(k)s, primarily due to technological issues.
But the reality is that investors are asking for ETFs, and plan providers will sooner or later have to develop or purchase the technology to cater to the growing number of ETFs investors are asking for.
Midsize investment management firms are rapidly developing new collective investment funds to cater to smaller pension plans present in the market, as well as offering niche products to the larger pension plans which are looking to provide diversified investments to their pension participants.
The collective investment funds’s attractiveness is driven by two key factors: low cost and ease of use. The primary driver for the inherently low cost for collective investment fund is the less rigorous regulatory burdens placed upon the investment managers and trustee. In order to attain the lowest possible cost, however, all parties involved need to seek the trustee able to offer the lowest servicing cost. In order for a trustee to accomplish this, their process must be as fully automated as possible, with as little manual intervention as possible.
Jerry Cooper, senior editor, The Trust Advisor Blog.
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