Morningstar - Q1 2021 - 15

Dispatches

now yields 1.7%, while the remaining 40% in
the hybrid investments would generate about 1.5%
in income.) In contrast, because bond yields
have plummeted, an index balanced fund now
distributes about 1.5%.

opportunities today. In such a climate, buyers may
swallow hard and continue to own Treasuries,
solely to achieve diversification. Such a decision
would make sense. However, they may wish
to cut their allocations, given today's prices. K

ranking member, Rep. Kevin Brady, R-Texas,
introduced Secure 2.0, which has a good chance
of passing. In this article, we will walk
through a few of the key provisions of this new
retirement bill.

Sadly, there's no cost-free way to achieve the
full benefits of investment-grade bonds.
Save for cash, competing investments do not
offer the same combination of high stability
and protection against stock market downturns.
Switching from bonds to preferred stocks
and utilities will immediately increase portfolio
yield and likely make for higher long-term
returns, but with the drawback of raising portfolio
volatility. This lunch doesn't come for free.

John Rekenthaler is a vice president with Morningstar
Research Services LLC. He is quick to point out that the
views expressed in Ivory Towers are his own.

Making Defined-Contribution Plans Cheaper
for Government Employees

To What Purpose?

Should bonds remain part of the allocation if they
only provide diversification?
Ideally, no. When holding a diversified portfolio
of risky investments, one hopes that each
asset class will pull its own weight. Otherwise, one
could just own Treasury bills, which over history
have posted a flat long-term real return, with
their nominal performance essentially matching
the rate of inflation.
Exceptions could be made for assets that
consistently zig when the rest of the portfolio zags,
thereby making the benefit from diversification
so powerful that it can overcome modestly
(but not strongly) negative returns. But Treasuries
do not possess that attribute, as they tend
to slide along with the stock market when inflation
unexpectedly rises. High-quality bonds are
an excellent hedge against recessions-but not
necessarily against other causes of stock
market declines.
That said, one can only work with what the financial
markets provide. Forty years back, investors
could select from a wide variety of securities that
offered high yields-bonds of all flavors,
along with most stocks. They enjoy far fewer such

Congress Looks
at Secure 2.0 Despite
a divided country,
both parties agree on
some retirement
provisions.
POLICY

Aron Szapiro
The November election was contentious, and
the two political parties are miles apart on
most policies. Retirement policy, however, has
been a rare bright spot of bipartisanship.
In 2019, U.S. Rep. Richard Neal, D-Mass., the
chairman of the House Ways and Means
Committee, managed to get the Secure Act-
more formally known as the Setting Every
Community Up for Retirement Enhancement
Act-through the House by a vote of 417-3.
The bill later passed the Senate as part of
a larger appropriations bill and was then signed
into law by President Donald Trump. The act
created open pooled employer plans, among other
things. In 2020, Neal and the committee's

Secure 2.0 would allow state and local governments
to offer collective investment trusts, or CITs, in
their 403(b) retirement plans for teachers and other
public servants. This change would meaningfully
help these workers save for retirement because
CITs are typically cheaper than registered
open-end mutual funds. (CITs are already allowed
in supplemental 457 plans.) CITs are cheaper
because they are not marketed and regulated in
the way that mutual funds are. Thus, their
administrative and regulatory costs generally are
lower, allowing for lower expense ratios to be
charged to investors.
The differences in costs are eye-popping. When
comparing the net expense ratios of CIT tiers and
mutual fund share classes of the same strategy,
CITs are cheaper 91% of the time,1 and even when
considering only the least expensive CIT tier and
mutual fund share class, CITs are cheaper 82%
of the time. The asset-weighted average expense
ratios of both active and passive CITs are roughly
half those of their mutual fund counterparts.
Across all investment strategies, as of year-end
2019, the average passive CIT cost fewer
basis points than the average passive mutual fund.
Average Asset-Weighted Expense Ratio by
Investment Vehicle and Management Style
Active (%)

Passive (%)

Mutual Fund

0.65

0.08

Collective Investment Trust

0.37

0.05

Source: Morningstar Direct. Data as of 12/31/2019.

Similarly, the average active CIT cost less in basis
points than the average active mutual fund.2

1 This estimate incorporates some double counting, as multiple tiers and share classes can be from the same strategy.
2 While the Morningstar CIT database is comprehensive, covering more than 6,700 CIT tiers, the most competitive CIT fees are negotiated on a client-by-client basis and, therefore, not reported
to public databases.

Morningstar - Q1 2021

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