As CIT Adoption Surges, Retirement Industry Races to Modernize

Collective investment trusts are rapidly replacing mutual funds on the investment menus of the defined contribution retirement plans that can utilize them.

Over the past decade, the bank-maintained investment vehicles have steadily displaced mutual funds across defined contribution plans, driven by lower costs and growing institutional demand. Today, CITs hold a majority of target-date-fund assets in the defined contribution plans that can use them, a shift industry observers expect will continue.

As of 2023, CITs held 34% of assets inside 401(k) plans with at least 100 participants, according to the Investment Company Institute.

But as adoption accelerates—and with bipartisan legislation gaining momentum to allow CITs inside 403(b) retirement plans, industry participants say the next phase of growth will depend on the operational systems that support the products, rather than on investment demand.

As CIT assets continue to grow, legacy recordkeeping technology, manual processing, reconciliation workflows and fund administration infrastructure all face increasing pressure. While industry executives say those challenges are manageable, many acknowledge modernization efforts are becoming increasingly urgent before potentially millions of additional retirement savers are able to access the investment vehicles.

That is prompting providers, recordkeepers and industry infrastructure firms to prepare now, rather than wait for Congress to act.

“Whether or not the bill moves forward and actually becomes law, people are starting to think about—both on the recordkeeper side and on the CIT side—about how to make these relationships and the operations work as seamlessly as possible,” says Lisa Gomez, a former assistant secretary of labor for the Employee Benefits Security Administration and now president of LMG Collaborative Consulting Solutions. 

To be sure, the INVEST Act, which includes the CITs to 403(b) provision cleared the House but has stalled in the Senate.

Growth Amidst Aging Infrastructure

For years, CIT adoption has been fueled primarily by economics.

Unlike mutual funds, CITs are regulated as bank products, not as securities. That often allows providers and sponsors to offer lower-priced investments because the funds have lower operating expenses than similar mutual funds.

Unlike mutual funds, CITs are not regulated by the Securities and Exchange Commission. Instead, CITs are regulated by state and federal banking regulators—depending on the charter of the issuing bank—including the Office of the Comptroller of the Currency and state bank examiners, along with the Internal Revenue Service. CITs also fall under the Employee Retirement Income Security Act. They are not available in the retail market.

The regulatory difference in flexibility has allowed CITs to cost investors less. According to Morningstar, the average CIT fund’s expense ratio is approximately three times cheaper than that of a similarly focused mutual fund. For passively managed funds, CITs’ expense ratios are approximately four times cheaper than a mutual fund, Morningstar reported.

That cost advantage has increasingly made CITs the default investment vehicles inside many defined contribution plans, particularly target-date strategies. But their rapid growth has also exposed concerns about the industry’s operational foundation.

An ICI white paper released this year argues that many providers’ servicing functions—including fund onboarding, pricing, reconciliation and transaction processing—still rely on manual workflows that developed when CITs represented a much smaller share of the retirement marketplace.

Preparing Before Legislation Arrives

Those operational conversations have taken on greater significance because Congress continues to consider legislation that would permit collective investment trusts within 403(b) retirement plans.

The proposal enjoys broad bipartisan support and backing from much of the retirement industry, which argues the change would give teachers, nonprofit employees and healthcare workers access to the same investment options already available in many 401(k) plans.

Melissa Kahn, a retirement public policy strategist at State Street Investment Management, says firms have already begun preparing implementation strategies, despite the legislation’s continued pending status.

“We just got something yesterday from one of our investment strategists who is putting together the game plan right now if this passes,” Kahn says. “It’s going to be a lot of education.”

Similarly, Chris Bailey, who leads research for Cerulli’s retirement practice, says the industry has figured out how to utilize CITs in large plans. Some 89% of CIT assets are in plans with at least $500 million in assets, according to Morningstar, indicating that getting over operational hurdles should not be an issue in the 403(b) market. Instead, major challenges will be educating plan sponsors and establishing infrastructure.

“There’s a degree of education that’s going to need to be done,” Bailey says. “It’s about getting out in front of plan sponsors who may or may not have be aware of CITs and having conversations about the benefits and the drawbacks and just getting that conversation started.”

That preparation extends well beyond explaining investment products to clients.

Among the questions sponsors should ask, Gomez says, are whether recordkeepers can administer CITs today, whether governance documents require amendments, and whether existing operational systems can support the products if demand increases.

Modernization

Despite operational bottlenecks, industry participants largely reject the notion that existing infrastructure cannot support another wave of growth in CIT demand. Instead, they describe the challenge as one of modernizing existing infrastructure.

Talia Klein, managing director and head of wealth and investment solutions at DTCC, says the industry has already demonstrated its ability to support CIT growth.

“That level of adoption demonstrates the industry has already put a significant amount of operational capability behind supporting CITs at scale,” Klein says.

If Congress ultimately opens CITs to the 403(b) market, she estimates the industry could see roughly $600 billion in additional CIT assets over time if adoption mirrors the 401(k) market. (ICI data show assets in 403(b) plans total more than $1.5 trillion.) But she argues the underlying infrastructure is already largely in place.

For instance, Klein says DTCC’s Fund/SERV platform, which processes more than one million fund transactions daily, has seen the use of CIT securities grow nearly 20% over the past year.

Beyond Adoption

That preparation reflects how far CITs have evolved.

Many observers expect CITs to take a significant piece of the 403(b) market once legislation is passed and expect the investment vehicle to continue taking market share in the 401(k) market. But they say firms in the industry are increasingly focused on ensuring that operational plumbing evolves alongside one of retirement plans’ fastest-growing investment vehicles.

“You definitely want to have a situation where you’re prepared for this in advance,” Gomez says, “and not [have a situation in which] they turn on the green light for it, and … it’s, ‘OK, now you can do it,’ but operationally, [you] can’t do it.’”