401(K) market a tough sell

Exchange-traded funds make up a tiny fraction of the investments offered by 401(k) plans, but they could claim a larger share of the market as key providers add them to their platforms

Exchange-traded funds make up a tiny fraction of the investments offered by 401(k) plans, but they could claim a larger share of the market as key providers add them to their platforms.

TD Ameritrade Trust Co. and The Charles Schwab Corp. are the latest companies to join the fray, possibly paving the way for wider acceptance among financial advisers. TD Ameritrade this year added ETFs to its retirement platform for financial advisers, while Schwab plans to launch an ETF-only platform next year.

BlackRock Inc. and ShareBuilder Advisors LLC also have an ETF foothold in the 401(k) market.

But these providers are fighting a tough battle to gain the attention of financial advisers overseeing small to midsize retirement plans, which are largely weighted toward mutual funds.

DROP IN THE BUCKET

ETF assets in 401(k) plans totaled an estimated $5.49 billion at the end of last year, up from about $4 billion in 2009, but are still dwarfed by plan assets in mutual funds, according to data from Cerulli Associates Inc. In fact, ETFs account for less than 1% of assets in the wider 401(k) industry, according to Tom Modestino, associate director of retirement markets at Cerulli.

“Major providers have yet to aggressively promote these investments on their platforms,” he said.

With their low-cost fee structure, transparency and option of intraday trading, ETFs offer 401(k) plan participants some advantages over mutual funds, especially in light of more-stringent fee disclosure rules due from the Labor Department next April.

“A cheap, small-plan retirement benefit solution could be an all-ETF lineup,” Mr. Modestino said.

BACK-OFFICE MIGRANES

However, placing ETFs in plans can create administrative headaches. For example, to deal with the payment of commissions and to handle ETF transactions that occur on a scheduled basis, record keepers have had to adjust their accounting and trading architecture, noted Scott Burns, director of ETF research at Morningstar Inc.

Also, since most record keepers’ platforms are designed to trade mutual funds at the end of the day, they lack the capacity to buy and sell ETFs during the trading day.

“I’ve had clients consider ETFs, but not a single one uses them,” said Jim O’Shaughnessy, managing partner of Sheridan Road Financial, which manages more than $1 billion in retirement plan assets. “Clients see the hurdles and decide not to implement them.”

Another advantage of ETFs versus mutual funds — the fact that they are less likely to realize capital gains — is irrelevant because 401(k) returns are tax-deferred.

“The main attribute of ETFs — which includes tax efficiency — is not applicable in a 401(k),” said Michael J. Malone, managing principal of MJM401k.

Fidelity Investments, the largest defined-contribution record keeper, doesn’t make ETFs available to its retirement plan sponsors because employer demand hasn’t been strong enough to warrant adding them. Participants, however, may access ETFs through a brokerage option.

“While they discuss ETFs, some of our clients have equated it to having an annuitized option in a plan,” said Beth McHugh, vice president of market insights at Fidelity Investments. “Nobody’s willing to pull the trigger.”

She said that while intraday trading can be a plus, long-term investors may not require that feature. “We have no plans to add ETFs within the plan,” Ms. McHugh said.

Enter Charles Schwab and TD Ameritrade, which experts said could make ETFs in retirement plans popular with advisers because of their dominance in the custody business.

PASSIVE LINEUPS

“Folks don’t understand that 401(k)s for small businesses are very much an adviser business,” said Scott Burns, director of ETF research at Morningstar Inc. “The plans connect with specialist advisers to create a platform and package for employees.”

Plan sponsors, interested in eliminating the revenue-sharing that’s inherent with actively managed funds, are asking about passive lineups at Charles Schwab, said Steve Anderson, head of Schwab Retirement Plan Services Inc.

While its plans for 401(k) ETF offerings are nascent, the company expects to offer about 15 to 20 ETFs on its platform. The platform would permit real-time ETF trading for self-directed participants, though Schwab will team up with a third-party advice provider to offer a managed solution for the majority of participants, who are less inclined to invest on their own.

Those investments will trade on a quarterly basis for re-balancing and glide path maintenance, Mr. Anderson added. For plan sponsors who worry about day-trading by participants, the indexed-mutual-fund option might seem more attractive, he said.

“The key driver in going with an ETF platform, plus managed service, is that it’s a comprehensive turnkey program for the vast majority of participants at the lowest costs,” Mr. Anderson said.

Others are watching from the sidelines with great interest.

“From our perspective, we can provide the right types of ETFs for 401(k) platforms, but we’re anxious to see more interest from the large plans prior to doing that,” said Dick Davies, managing director of defined contribution for Russell Investments’ institutional business.

A DIFFERENT TARGET

Observers noted that while it may take some time for ETFs to catch on in the 401(k) business, they may become more popular sooner in custom target date funds. Franklin Templeton Investments places 5% of its target date funds’ assets in ETFs to allow the firm to make tactical adjustments to its equity and fixed-income allocations. Meanwhile, BlackRock makes iShares target date ETFs available to 401(k) plans.

Elite advisers could customize target date funds of ETFs for their retirement plan clients.

“Smaller advisers justify their value-add by making target date funds out of ETFs and then offering them on platforms,” Mr. Burns said.

“You have to have a 401(k) that puts participants into professionally managed accounts or a target date fund as the first line of defense; if you do that, then ETFs make a lot of sense,” said retirement plan consultant Chip Morton, founder and president of FiduciaryPlanReview.com. He manages $800 million in assets.

Email Darla Mercado at [email protected]