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Schwab's all-ETF 401(k) platform revs up competition

Feb 7, 2014 @ 12:01 am

By Darla Mercado

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There's no question that Schwab's all-ETF 401(k) offering will inspire competitors to do the same, but whether plan sponsors will embrace these ETF-based plans remains to be seen.

Charles Schwab & Co. Inc. on Wednesday announced the long-awaited launch of its all-ETF 401(k) platform, after straightening out kinks pertaining to trades of fractional shares of exchange-traded funds. The launch previously had been set for the fourth quarter of 2013, but it was delayed as the firm sought a way to contend with fractional shares of ETFS — which only trade in whole shares.

Schwab is the latest to join a small but growing group of firms that offer ETFs in retirement plans and not just exclusively via a brokerage window. Others include TD Ameritrade Inc., Invest n Retire and ShareBuilder. There are also a number of asset managers who are using ETFs within target date funds, including J.P Morgan Asset Management.

Retirement plan record keepers and asset managers who are making ETFs available are staking the funds' proliferation on plan sponsors' renewed focus on transparent pricing within 401(k)s.

“With mutual funds, there are lots of different share classes,” said Steve Anderson, executive vice president of Schwab Retirement Plan Services. “We're skipping all that — all those share classes — to get to the bottom, which is where the industry needs to be.”

In Schwab's model, costs can be as low as 10 basis points for the ETFs, and 45 basis points for an optional participant investment advice component. Advisers receive no commissions for selling this model.

In practice, however, observers are finding that when it comes to ETFs in retirement plans, low costs alone aren't enough to attract the flows that go to mutual funds. For one thing, mutual funds and 401(k)s are intertwined. Most record-keeping systems are built around mutual funds.

“The mutual fund industry took off in the 1980s when 401(k)s came about,” said Skip Schweiss, president of TD Ameritrade Trust Co. “They really grew up together, and it's going to be difficult for ETFs to displace that. But there is room for them to play.”

Indeed, even though TD Ameritrade has made ETFs available alongside mutual funds in 401(k)s since March 2011, only 11% of the firm's plan clients have one or more ETFs in its plan menu. Four percent of all retirement plan assets on TD's platform are in ETFs.

For Schwab, entering into this area dominated by mutual funds required that it create a special workaround to handle fractional shares. Its record-keeping business will submit trades to the directed trustee where the plan asset are held in custody. Trading will take place through Schwab's broker-dealer. Hypothetically, if a plan needs 10.5 shares, Schwab will purchase 11, and the broker-dealer will own the residual portion of the share, according to Mr. Anderson.

But advisers and plan sponsors are leery of permitting participants to partake in intraday trading or offering a lineup of ETFs from which workers can choose. “I'm not keen on providing 25 ETFs in a portfolio,” said Vern Sumnicht, chief of iSectors, an ETF-focused investment manager. “It's difficult for an individual worker to decide how to take those ETFS and create a portfolio that's right for them.

Gerald Wernette, director of retirement plan services and principal with Rehmann Financial, noted that more plan sponsors are asking about using ETFs, but they're guarded about it. “Part of me thought that that with all of the noise about low fees, there would be this mad clamor for these kinds of platforms and resources,” he said.

Instead, there are lots of questions but no real hurry to use them. Plan sponsors still don't quite understand them, and advisers harbor concerns that passively managed vehicles may not always be the answer for retirement plans, Mr. Wernette noted. That said, the firm does use ETFs in plans, just in a different capacity.

“We use collective funds, and they're predominantly built with ETFs. There is a place for them, and that place is more in a managed advisory environment, rather than letting people freely pick and choose as they see fit,” Mr. Wernette said.

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