One approach some companies are taking to both rein in costs and avoid style drift is to offer investment options through collective trusts instead of mutual funds. Collective trusts, which are ERISA-qualified vehicles that are only available to institutional investors like 401(k) plans, have long been used by defined-benefit plans. Because they are meant for an institutional audience that is highly attuned to the issue of style drift, collective trusts tend to be more style-pure than mutual funds.
Collective trusts have not been widely used in the defined-contribution market, because employers were concerned about the lack of public information about their performance, but the growing availability of fund data on company Websites and from financial-information providers like Morningstar has eliminated that obstacle. As a result, collective trusts are now starting to cross over into defined-contribution plans as employers focus more on lower-cost options, with 41 percent of plans using them in 2006, up from 32 percent in 2003, according to research from Morningstar and Greenwich Associates.
“In many cases, collective trusts have the exact same manager as a mutual fund, but they are a different type of vehicle,” says Hewitt’s Hess. Because they are not publicly traded, there are fewer regulatory and administrative costs associated with collective trusts, which results in lower fees. They also have more-flexible fee structures, with lower costs for plans with more assets.
For the Savviest
For the most sophisticated plan participants, some employers are now offering self-directed brokerage accounts within their 401(k) plans. While only about 18 percent of employers currently offer such an option, the number is growing, says Hess. Just 2 percent of employees use the brokerage option when it is available, but it is a good way to appease the savviest investors, who also tend to be the most vocal, she says.
“If you’re making a big change in your plan and reducing the number of funds, there are going to be people in the plan who are downright upset, and it tends to be the people with the bigger balances,” says Hess. The average user of self-directed brokerages has $100,000 in plan assets, compared with about $80,000 for the average 401(k) participant, according to Hewitt.
Users of the self-directed brokerage option typically pay a fee, and they may sign an agreement that acknowledges that the responsibility to research investments lies with them, not the plan sponsor. By providing the vocal minority with the option to invest in a wide array of funds or securities that have not been screened by the company, employers can then comfortably pare down their core plan offerings to the 10 or 12 funds that will meet the needs of most employees. Those employers who are concerned about the risk that comes with a self-directed brokerage account can set limits: employees may be restricted to investing only in mutual funds, or there may be a cap on the percentage of their contributions they can devote to the brokerage account.