Understanding Collective Investment Funds: Smart Money Management

A collective investment fund (CIF), also known as a collective investment trust (CIT), is a group of pooled accounts held by a financial institution. They enable investors to invest in a basket of securities from different companies and spread the investment risk. Once the collective sum is pooled, a professional fund manager will then use this capital sum to manage a portfolio of investments. CIFs are not regulated by the Securities Exchange Commission (SEC) or the Investment Act of 1940 but operate under the regulatory authority of the Office of the Comptroller of the Currency (OCC).

Types of collective investment funds

Collective investment funds are also known as collective investment trusts (CITs) or collective investment schemes (CIS). They are a group of pooled accounts held by a bank or trust company. The financial institution groups assets from individuals and organisations to develop a single larger, diversified portfolio.

There are two types of collective investment funds:

• A1 funds: Grouped assets contributed for investment or reinvestment.
• A2 funds: Grouped assets contributed for retirement, profit-sharing, stock bonuses, or other entities exempt from federal income tax.

CITs/CIFs are not regulated by the Securities Exchange Commission (SEC) or the Investment Act of 1940 but operate under the regulatory authority of the Office of the Comptroller of the Currency (OCC). They are similar in structure to mutual funds but are unregistered investment vehicles, more akin to hedge funds.

The term "collective investment scheme" is a legal concept deriving from a set of European Union Directives to regulate mutual fund investment and management. In the UK, the Financial Services and Markets Act 2000 defines a CIS as:

> "...any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income."

CISs may be regulated or unregulated, depending on whether or not they have been given regulated status by the Financial Conduct Authority (FCA).

Some other types of collective investment vehicles include:

• Open-end funds: These are equitably divided into shares, which vary in price in direct proportion to the variation in the value of the fund's net asset value.
• Closed-end funds: These issue a limited number of shares or units in an initial public offering (IPO) or through private placement.
• Exchange-traded funds (ETFs): These combine characteristics of both closed-end and open-end funds and are traded throughout the day on a stock exchange.
• Unit investment trusts (UITs): These are issued to the public only once when they are created and generally have a limited lifespan.

Collective investment vehicles can also vary in availability depending on their intended investor base:

• Public-availability vehicles: Available to most investors within the jurisdiction they are offered, with some restrictions on age and size of investment.
• Limited-availability vehicles: Limited to experienced and/or sophisticated investors, with high minimum investment requirements.
• Private-availability vehicles: Limited to family members or whoever set up the fund. These are not publicly traded and may be arranged for tax or estate-planning purposes.

How collective investment funds work

A collective investment fund (CIF) is a group of pooled accounts held by a financial institution, typically a bank or trust company. CIFs enable investors to pool their money and invest in a diverse portfolio of securities from different companies, thereby spreading the investment risk.

Once the collective sum is pooled, a professional fund manager uses this capital to manage a portfolio of investments. The fund manager combines different fiduciary assets into a single account, allowing for a reduction in operational and administrative expenses. The fund is structured with a chosen investment strategy and objective in mind, aiming to maximise investment performance.

Participants in the fund do not own any specific asset held in the CIF but are considered beneficial owners, holding an interest in the fund's aggregated assets. The bank or trust company acts as a trustee or executor, with legal title to the assets in the fund.

CIFs are not regulated by the Securities Exchange Commission (SEC) or the Investment Act of 1940 but instead operate under the regulatory authority of the Office of the Comptroller of the Currency (OCC). They are also known as collective investment trusts (CITs) and are available mainly through employer-sponsored retirement plans, pension plans, and insurance companies.

The primary objective of a CIF is to lower costs through economies of scale, combining profit-sharing funds and pensions. By pooling funds together, participants can benefit from reduced transaction costs and increased asset diversification, ultimately reducing investment risk.

CIFs are specifically designed by banks to enhance their investment management capabilities by gathering assets from various accounts into a single fund. This allows banks to decrease operational costs and provide participants with access to investment opportunities that would otherwise be unavailable to individual investors.

The first collective investment fund was created in 1927, and since then, collective investments have surged in popularity. Today, they are one of the most common ways for individuals to invest in stock markets and other types of assets.

Advantages of collective investment funds

Collective investment funds (CIFs) are a type of investment vehicle that offers several advantages over other forms of investing. Here are some of the key benefits:

Diversification of Investments: CIFs pool money from multiple investors, allowing for a more diversified portfolio that reduces investment risk. By investing in a range of securities, the capital risk is lowered as it is spread across various holdings. This diversification also helps to minimise unsystematic risks.

Economies of Scale: CIFs benefit from economies of scale, which leads to lower transaction costs for investors. The larger, pooled fund can take advantage of reduced fees and expenses compared to individual investors making smaller transactions.

Professional Investment Management: CIFs are managed by professional investment managers who have the expertise to potentially offer better returns and more effective risk management. These managers make investment decisions on behalf of the investors, allowing them to benefit from their knowledge and experience.

Reduced Costs: CIFs have lower management and operating costs compared to other investment options, such as mutual funds. This is because CIFs are not regulated by the Securities and Exchange Commission (SEC) and do not have to meet certain reporting requirements, resulting in lower fees for investors.

Tax Advantages: In certain jurisdictions, such as the UK, collective investment vehicles like open-ended investment companies (OEICs) and unit trusts are exempt from corporation tax on UK dividends. Additionally, collective investments may offer favourable capital gains tax rates and allow for the utilisation of personal or trustee capital gains tax annual exempt amounts.

Transparency and Suitability: Collective investments offer transparency in pricing and can be suitable for a range of investors, including those with trust structures or seeking income-producing or growth-oriented investments.

History of collective investment funds

The first collective investment fund (CIF) was created in 1927. However, when the stock market crashed two years later, these pooled funds were blamed for the ensuing financial hardships, and banks were restricted to offering CIFs only to trust clients and through employee benefit plans.

In the 21st century, CIFs began to be listed on electronic mutual fund trading platforms, increasing their visibility and trading frequency. The Pension Protection Act of 2006 effectively made them the default option for defined contribution plans, and target-date funds (TDFs) became popular, with the CIF structure being particularly well-suited to this sort of long-term vehicle.

Since 2012, the use of CITs has grown by 56% within DC plans, while the usage of mutual funds has decreased. This trend is expected to continue, with interest in CITs steadily growing within defined contribution plans due to their increased transparency, ease of use, and flexibility compared to earlier versions.

Differences between collective investment funds and mutual funds

Collective investment funds (CIFs) and mutual funds are similar in structure, but there are some key differences.

Firstly, CIFs are only available to institutional investors and within employer-sponsored retirement plans, such as 401(k) plans, whereas mutual funds are available to the general public and can be purchased directly or through a financial intermediary, such as a broker. CIFs are also not insured by the Federal Deposit Insurance Corporation (FDIC).

Secondly, CIFs are not regulated by the Securities and Exchange Commission (SEC) or the Investment Act of 1940, whereas mutual funds are heavily regulated by the SEC under the Investment Company Act of 1940. CIFs are overseen by bank regulators and are subject to ERISA, which is administered by the Department of Labor. This regulatory difference results in lower operating costs for CIFs compared to mutual funds, as they don't have to meet SEC reporting requirements.

Thirdly, CIFs have different fee structures based on services and assets, while mutual funds have set asset-based fees determined by their share class structure. Additionally, CIFs are generally void of redemption fees, whereas mutual funds may be subject to such fees.

Another difference lies in the oversight and management of the funds. CIFs are controlled by a bank or trust company, which acts as a trustee or executor, while mutual funds are led by a mutual fund manager or group of managers approved by a board of directors.

Lastly, CIFs cannot be rolled over into Individual Retirement Accounts (IRAs) or other accounts, whereas mutual funds typically offer this option to participants.

Frequently asked questions