'Collective funds' gain traction in 401(k)s

Don't look now, but your favorite 401(k) mutual fund may be going the way of the VHS tape.

In a drive to cut costs, 401(k) plans are replacing familiar mutual-fund investment options with more-obscure vehicles known as "collective investment funds."

Just like mutual funds, collective funds pool investors' assets and invest in stocks, bonds and other securities. The chief difference: Collective funds are typically available only in retirement plans. Because they aren't sold directly to the general public, they generally aren't regulated by the Securities and Exchange Commission.

Collective funds tend to be substantially cheaper than mutual funds, largely because they don't have to comply with SEC regulations or market to retail customers. That's driving 401(k) plans to embrace these products, which are offered by big fund providers like Fidelity Investments, Vanguard Group and Charles Schwab Corp. as well as by banks and trust companies.

Only 58 percent of large defined-contribution plans such as 401(k)s used retail mutual funds in 2007, down from 65 percent in 2003, according to research and consulting firm Greenwich Associates. By contrast, 39 percent of such plans used collective funds last year, up from 33 percent two years earlier. Other common 401(k) investment options include institutional-class mutual funds sold to retirement plans and other large investors, and "separate accounts," which are custom-designed for a single retirement plan.

Since fees eat into returns, lower-cost investment options can mean a bigger nest egg for 401(k) plan participants. But these funds can also have substantial drawbacks. They're not listed in the newspaper or on financial-news Web sites, and they often offer far less information on their performance and holdings than mutual funds. Collective funds aren't required to send out prospectuses, and some value their holdings and update performance only monthly or quarterly.

Also, collective funds, which are also known as collective trusts, can't be rolled over to an individual retirement account when the participant leaves the 401(k), so participants have to transfer their funds into other investment options if they take these assets from the plan.

Some investors aren't eager to leave behind mutual funds for the unfamiliar world of collective funds as their company makes the switch. Bob Kennedy, 57 years old, is one of them. A salesman for AT&T Inc. in Vadnais Heights, Minn., he happily invested his 401(k) assets in brand-name mutual funds for years.

But in recent months, AT&T revamped its 401(k) investment options for many employees, removing mutual funds from the core lineup but offering a "brokerage window" that lets workers invest as much as half their vested balance in mutual funds and stocks. The core investment options are now a company-stock fund and collective funds with names like AT&T Total Return Bond Fund and AT&T U.S. Stock Fund.

Mr. Kennedy says he "did quite well" in the traditional mutual funds, and "I was sad to see them go." What's more, he has found the information on the new collective funds a bit sparse. "You have to take a leap of faith," he says. He was thinking of retiring next year, but much depends on how his portfolio performs. "I wish they would have left (the plan) alone for a while," he says.

AT&T spokesman Rolf Gatlin says the shift to collective funds gives participants "access to institutional-quality money management at a low cost."

Collective funds have been around for decades, but employers and money managers are embracing them now as 401(k) plan fees come under increasing scrutiny. Lawmakers have been introducing bills aimed at creating better 401(k) plan fee disclosure, and recent lawsuits filed by plan participants against employers have claimed that workers were charged excessive 401(k) fees.

Late last year, the U.S. Department of Labor released new regulations making it easier for employers to automatically direct workers' 401(k) assets into certain types of collective funds if the workers don't select their own investments, and the department this week proposed new regulations to improve 401(k) fee disclosure to workers.

"We are seeing a huge explosion in collective trusts," says Steve Deutsch, director of collective trusts and separate accounts at investment research firm Morningstar Inc.

Major employers are making the move to collective funds - and often dropping mutual funds from their 401(k) lineup. DuPont Co. revamped its 401(k) plan's investment options in February, replacing a lineup that consisted primarily of mutual funds with one that includes only collective funds and other non-mutual-fund options. Chrysler LLC, which started using collective funds in its 401(k) plan about five years ago, when it was part of DaimlerChrysler AG, is adding four more of the products to its lineup this year.

Money managers are scrambling to meet the growing demand for collective funds. A record 151 collective funds were launched last year, up 47 percent from a year earlier, according to Morningstar.

At Intel Corp., which has about $9 billion in its defined-contribution plans and offers participants both collective and mutual funds, collective-fund expenses are as low as 0.01 percent of assets, says Stuart Odell, the company's director of retirement investments. That's far below what the typical institutional-class mutual fund charges.

A typical lineup of collective funds is often roughly 0.3 percentage point cheaper than a comparable lineup of retail mutual funds, says Alison Borland, defined-contribution consulting practice leader at Hewitt Associates.

But some traditional mutual funds can be nearly as cheap. At Vanguard, for example, retirement plans can get mutual funds that track the Standard & Poor's 500-stock index for as little as 0.025 percent, says Gerry Mullane, principal in Vanguard's institutional investor group. Given those bargain-basement offerings, the plans that Vanguard administers are generally sticking with mutual funds, he says.