UC adds collective investment trusts to its 403(b) plans

The University of California will offer in October a pair of collective investment trusts for its 403(b) plan, marking a rare instance of a 403(b) plan, other than a church-sponsored one, offering such an investment option.

Collective investment trusts are allowed for most DC plans — 401(k), 457(b), 401(a) and church-sponsored 403(b). But the biggest providers of 403(b) plans — colleges and universities, public school systems and hospitals — cannot ​ offer these options, which many sponsors use to reduce costs to participants.

"We saw an opportunity to lower fees," said Arthur Guimaraes, chief operating officer for the University of California, Oakland.

"Costs matter," Mr. Guimaraes said, referring to the addition of collective investment trusts and to other changes to the university's plans that will take place Oct. 2. "This is another area to improve participant outcomes."

The potential impact on the 403(b) plan world is unclear because the university is benefiting from a private-letter ruling from the Internal Revenue Service.

Although the IRS letter provided an exemption for prohibitions​ on non-church 403(b) plans offering collective investment trusts, the university declined to provide the letter, describe a summary or say when the ruling was issued. Mr. Guimaraes would only say the ruling was "not recent."

Sources familiar with 403(b) plans said offering a collective investment trust in non-church plans is rare. DC consultants remarked that allowing 403(b) plans to offer collective investment trusts has slipped through the regulatory and legislative cracks over the years.

"It's the way the regulations were written," said Mike Volo, a senior partner, based in Wellesley, Mass., for Cammack Retirement Group.

"It's just the history of legislation," said Dan Pawlisch, associate partner and 403(b) practice leader for Aon Hewitt, Chicago.

The 403(b) plan law was enacted in 1958; these plans could only offer annuities until 1974. The Employee Retirement Income Security Act of 1974 contained a provision that allowed 403(b) plans to offer mutual funds, and a 2015 law allowed church plans to offer collective investment trusts.

A 2016 report co-authored by Mr. Pawlisch advocated revising the law to allow 403(b) plans to offer CITs, among other recommendations. "The​ legislation hasn't changed," said Mr. Pawlisch. "It seems archaic in this day and age."

Although mutual funds are regulated by the Securities and Exchange Commission and are covered by the Investment Company Act of 1940, CITs are governed by the Office of the Comptroller of the Currency and are considered unregistered​ securities. CITs have fewer reporting requirements than mutual funds. CITs are maintained by banks or trust companies."Asset managers offer lower fees in collective vehicles in defined contribution plans," said Mr. Guimaraes, citing the main reason the university sought to use collective investment trusts. The offering of collective investment trusts is part of an investment lineup restructuring that affects not only the $15.7 billion 403(b) plan but also the $2.4 billion 457(b) plan and the $4.2 billion 401(a) plan — all part of the university's Retirement Savings Program.

This is the third major restructuring in recent years of the university's defined contribution plans designed to reduce fees and simplify the investment lineup (Pensions & Investments, March 30, 2015 and Jan. 20, 2014). "It's the next evolution," Mr. Guimaraes said.

University investment officials spent about a year developing the strategy for the latest changes, he said. The result is a product of discussions with the UC Retirement Savings Program Advisory Committee, UC Chief Investment Officer Jagdeep Singh Bachher, the UC regents' subcommittee on investments and the Academic Senate. Officials also consulted with the university's human resources department, as the plans' fiduciary; Mercer, the plans' consultant; and Fidelity Investments, the plans' record keeper.

Investment options are identical for each plan, so the 457(b) and 401(a) plans also will offer the collective investment trusts.

For its three DC plans, the university is converting the Fidelity Growth Company Fund, an institutionally priced mutual fund, to a collective trust called the UC Growth Company Fund. The expense ratio will drop to 43 basis points from 66 basis points. The fund has $600 million in assets among the three DC plans, including $480 million from the 403(b) plan.

The university also will convert the Fidelity Diversified International Fund, also an institutionally priced mutual fund, to a collective trust called UC Diversified International Fund. The expense ratio will drop to 58 basis points from 92 basis points. The fund has $125 million in assets among the three DC plans, including $95 million from the 403(b) plan.

"These funds will have a new name but (will) keep the same investment strategy and manager," said a university document sent to participants, obtained independently by Pensions & Investments. The funds "will have lower fees because they will have lower marketing and overhead-related costs than similar, publicly traded mutual funds."

Mr. Guimaraes said the use of "UC" in fund titles represents a continuing effort to employ a white-label approach to its investment lineup — offering a simpler explanation of each option's strategy.​

When the changes are enacted in October, all investment options will contain the "UC" white label designation — a target-date fund series, four fixed-income funds, three domestic equity funds, three international equity funds and two specialty stock funds.

In another fund restructuring taking effect Oct. 2, the university will switch the $1 billion institutionally priced share DFA Emerging Markets mutual fund​ to a separate account called UC Emerging Markets Equity. Dimensional Fund Advisors will remain the manager of the emerging markets separate account, using the same investment strategy. The expense ratio will be cut to 25 basis points from 58 basis points.

Among the other investment lineup changes, the $4.5 billion UC Global Equity Fund will be removed. Unless a participant makes a choice, 85% of assets will be mapped to the UC Domestic Equity Index Fund and 15% will be mapped to the UC International Equity Index Fund, according to the document sent to participants.

The global equity fund's asset allocation is similar to the combined assets of the two index funds, the document said. The global equity fund's expense ratio is four basis points. The UC Domestic Equity Index Fund has an expense ratio of 0.5 basis points and the UC International Equity Index Fund expense ratio is one basis point.

The global equity fund has a 5% allocation to private equity, 80% to U.S. equity and 15% to non-U.S. equity. Mr. Guimaraes declined to comment on how the university will address the private equity allocation.

The $1.6 billion UC Balanced Growth Fund also will be removed. Unless participants make a choice, assets will be mapped into the existing age-appropriate target-date series called UC Pathway Fund.

The university is acting because the target-date series offers a glidepath that becomes more conservative as participants approach retirement age whereas the balanced growth fund has a fixed equity to fixed-income ratio, the university document said.

The UC Balanced Growth Fund's expense ratio is 11 basis points; the UC Pathway Fund expense ratio ranges from six basis points to 11 basis points depending on the asset allocation.

Three funds will be renamed in keeping with the white-label strategy. The $228 million Vanguard REIT Index Fund becomes the UC Real Estate Fund; the $318 million Vanguard FTSE Social Index Fund becomes the UC Social Equity Fund; and the $451 million Vanguard Small-Cap Index Fund becomes the UC Domestic Small Cap Equity Fund. Vanguard remains the manager, the investment strategies are the same and expense ratios are unchanged.

The university document also reported that effective Dec. 31, the rebalancing of the underlying funds in the UC Pathway Fund target-date series will be transferred to an outside manager from the Office of the Chief Investment Officer, which will retain oversight responsibility.