One of my favorite moments in my career was convincing a bunch of investment adviser Kool-Aid drinkers to ditch their proprietary mutual funds and replace them with our affiliate trust company's collective investment trusts.
This was unheard of. Worse, I was in charge of a trust company, not the investment adviser. My request, needless to say, sounded a bit self-serving.
But I was convinced this was the right thing to do, even if it did seem more in my best interests than the firm's, let alone the potential clients. Here's why I liked the idea.
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Unlike mutual funds, common trust funds weren't under the thumb of the SEC. Earlier in my career, I had been involved in establishing the operations center for those aforementioned proprietary mutual funds. I learned the intricate ins and outs of making a mutual fund go – and the terrible compliance burden that came along with that.
The common trust funds I proposed would be regulated by the state our trust company was chartered in (and, by proxy, the Office of the Comptroller of the Currency). I had already went through one audit and, compared to out SEC audits, it was a breeze.
What's more, although our trust company clients could partake of these funds (as opposed to almost anyone when it came to our mutual funds), there were no Blue Sky Laws to contend with (state trust companies are permitted to operate in any other state that offers reciprocity).
This meant no state registration fees for the common funds vs. huge (exceeding six figures) state registration fees for mutual funds.
There were other fee savings due to less rigorous annual audits (it was the same audit, only not an "SEC" audit, which somehow generated additional costs), lack of licensing requirements to "sell" the common trust funds (mainly because you don't sell the funds, you sell the trust services associated with the funds), no need to continually send compliance filings to government agencies, and the ability to function without costly distribution platforms (although, as we shall see, one in particular was a double-edged sword.)
There was one factor that stood out above all these operating cost savings – that was the cost savings to the client.
Unlike mutual funds, where the investment management fee is charged to the fund and then allocated equally among all shareholders, our common trust funds had no "investment management fee" (since we were managing the portfolio ourselves and not hiring a third party).
Instead, trust company clients merely agreed to commingle their assets with other trust company clients. The only fee they paid was their usual trust services fee – and that fee could be different for different clients. That trust services fee, in other words, directly replaced the mutual fund investment management fee, but with the advantage that targeted clients could negotiate more favorable rates. For example, a larger plan would see fee breaks that a smaller plan. (Remember, this is back in the day before mutual funds figured out how to, well, sort of, do this).
I thought that negotiated fee advantage would be a win-win for both the client and our company. And, on the face of it, I was correct.
Unfortunately, for every ying there's a yang.
Remember that double-edged sword I spoke of earlier? Well, it swung back with a vengeance as employee participants began demanded daily pricing, daily access, and complete transparency.
Sure it was great we didn't have to submit those compliance filings, but those compliance filings turned out to be an asset we didn't have.
Even if we created them to mimic a mutual fund's SEC filing, the clients had to take our word for it, since there was no third-party oversight (either from auditors or regulators) on these filings. Finally, recordkeeping technology at the time could not easily handle non-mutual fund investments. Brokers were just then beginning to create integrated platforms based on DTCC registered mutual funds. That was the direction the industry was heading and that remains the dominant operating procedure today.
For all the technical advances today, common trust funds continue to beset by the same basic problems – the lack of standardization of independent compliance reporting, the lack of standardized platform access, and the general marketing and publicity limits associated with bank collective funds.
Sure, individual companies can solve these problems, but plan sponsors must rely on the word of these companies, not the power of a regulator, to ensure these solutions stay in place and continue to advance as mutual fund regulations advance.
I still like common trust funds. I still think they're more flexible than mutual funds. Unfortunately, I still think the naked truth is that the plan sponsor market has a way to go to catch up to the point where these advantages are no longer perceived as liabilities.
If you'd like to learn more, read "What is a "Collective Investment Trust" and Does It Make Sense for a 401k Fiduciary to Use One?" (FiduciaryNews.com, March 31, 2015).
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