After long wait, Schwab's all-ETF 401(k) platform opens for business

Dealing with fractional shares proved to be tricky, but firm thinks it has solved the problem

Feb 5, 2014 @ 12:08 pm

By Darla Mercado

charles schwab, 401(k), etf, retirement
+ Zoom
(Bloomberg News)

The Charles Schwab & Co. Inc.'s all-ETF 401(k) platform is finally out and open for business.

The firm Wednesday announced the launch of its long-awaited exchange-traded-fund platform for retirement plans — an offering eagerly anticipated by plan sponsors and financial advisers going as far back as 2011.

At that time, Schwab announced its bid to make retirement plans cheaper and then launched its Index Advantage 401(k) — an all-index mutual fund offering — in 2012.

The road to introducing the all-ETF platform has been a rocky one, especially because Schwab has had to grapple with the difficulty of handling fractionalized shares of ETFs.

Most record-keeping platforms are built to handle mutual funds, which trade at the end of the day and which can be purchased in fractional shares. ETFs, on the other hand, trade during the day and are purchased in whole shares.

“We wanted to use [the ETFs] as intended,” said Steve Anderson, executive vice president of Schwab Retirement Plan Services.

“You have small investors contributing weekly or monthly, and that might range from $100 a pay period to a couple hundred," he said. "We want them to be fully invested.”

Without a fractionalized approach, most people would sit in cash until they had enough money to buy whole shares, Mr. Anderson said.

To solve that issue, Schwab will purchase whole shares and use its broker-dealer entity to handle the matter of fractional shares, he said.

The firm's record-keeping business will submit trades to the directed trustee where the plan assets are held in custody. Trading will occur through Schwab's broker-dealer.

“In this situation, say the plan needs 10.5 shares,” Mr. Anderson said. “We would need to buy 11 shares.”

The broker-dealer will own the residual portion of the share, and the plan will always be whole.

Ensuring that this would comply with the Employee Retirement Income Security Act of 1974 as well as banking and broker-dealer rules, was arduous, Mr. Anderson said.

Indeed, it was widely forecast that Schwab would release its ETF-based platform in the fourth quarter last year.

In October, Mr. Anderson had noted that the firm was working on a way to accommodate trading with fractional shares, and Schwab was hammering out the finer details with regulators.

When it comes to pricing, 401(k) participants can expect to see fund expenses at about 10 basis points or less. Workers can also access an option to receive customized participant investment advice via GuidedChoice or Morningstar Inc. for an additional cost of 45 basis points.

Schwab is keeping its eye on a sweet spot of retirement plans with $20 million to $1 billion in assets. Whether that will shift its target market for this ETF solution remains to be seen.

As far as concerns on habitual intraday trading by participants, Mr. Anderson said that the firm has observed “little active trading” even among its brokerage window accounts, where clients already have access to a wide array of investments.

“We see a few trades [in the brokerage window] on a quarterly basis, mostly among those participants who are most engaged,” he said. “Rarely do we see active trading.”

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