PSNC 2019: DC Investment Ideas, ESG and CITs

From left: Todd Kading, LeafHouse Financial; Rita Fiumara, Brent Sheppard and Cameron Kleinheksel, Photo credit: Matt Kalinowski

The second day of the 2019 PLANSPONSOR National Conference, held last week in Washington, D.C., included a timely, in-depth panel discussion about new investment ideas for defined contribution (DC) retirement plans, with a particular focus on the subjects of environmental, social and governance investing (ESG) and collective investment trusts (CITs)

The expert panel included Todd Kading, president and co-founder of LeafHouse Financial; Cameron Kleinheksel, senior consultant with Plante Moran Wealth Management; Rita Fiumara, senior vice president and institutional retirement consultant at UBS Financial Services; and Brent Sheppard, partner and financial adviser at Cadence Financial Management.

Starting with ESG, Kading explained that the basic subject can be thought of as having two poles. On the one side, ESG can be “values-driven,” meaning that an investor wants to use environmental, social and governance investing approaches in order to express a specific belief or intention—for example addressing climate change or workplace inequality. On the other hand, ESG investing approaches that are “values-based,” in Kadin’s explanation, are embraced by those investors that see ESG as an opportunity for risk reduction and potential long-term outperformance.

Under this nomenclature, given the importance of the fiduciary duty and the need to consider the economics of a particular investment first and foremost, retirement plans that have or will embrace ESG are much more likely to be in the “values-based” camp.

Sheppard and Fiumara emphasized that the conversation about “ESG in DC plans” today is much more sophisticated than it was say, five or 10 years ago. There are many more ESG-labeled products on the shelf today, they explained, and the ESG theme is being programmed into many funds and investment products that do not explicitly carry an ESG label. Additionally, plan sponsors are running analyses of their existing fund menus to rate them from an ESG perspective, and using this type of thinking to help steer decisions about tailoring the investment menu.

“There has been a lot of progress, but the ESG investing landscape is still in its early stages,” Kleinheksel said. “Millennials will drive this trend moving forward. As early as 2025, 75% of the workplace could be made up of Millennials, and they are very plugged into this topic.”

“There is also more diversity in the participant base,” Fiumara observed. “They want to deploy their values in their portfolios, as do portfolio managers. The DOL’s position is still that fiduciaries may not sacrifice performance for any outside agenda. This used to be thought of as a hurdle to ESG, but now there is an understanding that ESG can drive outperformance. Corporations are recognizing their own opportunities having to do with sustainable practices. It’s about reputation, quality control and sustainability.”

Turning to the topic of collective investment trusts, the panel stepped through some of the key differences between CITs and mutual funds. They said the basic differences comes from the fact that CITs don’t have to abide by various reporting and disclosure rules put in place and policed by the U.S. Securities and Exchange Commission (SEC), which leads to potential cost savings. One other point of difference is that providers of CITs have more freedom versus mutual fund providers to create special pricing breaks and discounts for large or long-tenured clients. Advisers serving multiple clients can also help plan sponsors pool their resources to gain access to customizable CIT products.

“One suggested downside is that transparency for CITs isn’t as strong, but that argument makes less sense today, as the industry has evolved and digital reporting technology has become so prevalent,” Kleinheksel said. “Is one better than the other, mutual funds or CITs? It depends a lot on what size of entity you are and what your relationships with advisers and providers look like.”

Sheppard observed that CITs have evolved alongside the race to the bottom that has occurred in the passive mutual fund space.

“The fee reductions we’ve seen in passive mutual funds have, perhaps, undercut some of the appeal of CITs, but we should point out that fee reductions have occurred much more on the passive side, while active fund management fees remain higher,” Sheppard said. “For this reason, more and more asset managers are creating CIT versions of their most popular active mutual funds, so plan sponsors may want to look into that.”

Fiumara concluded that the use of CITs is one area where advisers can help sponsors a lot, especially those with good relationships with the various recordkeepers and asset managers that are influential in the DC space.

“The top recordkeepers often have special selling and service agreements with all the asset managers out there, which, in turn, makes it easy for us as advisers to create custom portfolios,” she explained. “Custom CITs can encompass more complex investment options that you don’t want to offer as standalone funds. There is an opportunity to build a unique fund-of-funds that matches the needs of the participant base, or even to create a CIT with a target-date structure.”