NEW YORK — Although exchange traded funds are growing at a torrid rate, with a new offering almost daily, one area where ETF growth has been slow is in retirement accounts.
That might be about to change. A number of developments in the 401(k) world are likely to boost ETF use there.
“What the retirement market did for mutual funds, it could do for ETFs,” said Jill Iacono, director of national accounts with
State Street Global Advisors in Boston. “Mutual funds sort of grew up within the 401(k) market, and that could happen with ETFs.”
The Pension Protection Act of 2006 encourages employers to enroll their workers in 401(k) plans automatically and then offers them protection to direct those contributions to sound investments such as asset allocation funds. Additionally, last month’s congressional hearing on 401(k) plans cast a harsh light on high fees in the plans and the lack of disclosure of how those fees are charged, often directly from investment returns.
“A lot of plan sponsors are going to have their eyes opened to fees, and they’ll finally see what they’re really paying for these plans,” said Darwin Abrahamson, chief executive of Invest n Retire LLC, a Portland, Ore.-based record keeper that provides ETFs to 401(k) plans.
Expenses typically lower
ETFs typically have lower expenses than their open-end brethren. And the funds don’t engage in revenue-sharing arrangements in order to get on a provider’s shelf, so there are no disclosure concerns.
Mr. Abrahamson’s firm can put together an all-ETF portfolio for less than 0.4% of assets, including record-keeping and administration fees, while mutual fund-based plans can cost upwards of 1%. He declined to disclose Invest n Retire’s assets under management, but he said his pipeline represents some $2 billion of assets in future business.
According to industry insiders, ETFs represent a scant 3% to 5% of the $2.5 trillion 401(k) market.
Up to now, there has been resistance among major 401(k) providers, largely because their trading platforms can accommodate only open-end mutual funds.
But observers also point to the richer fees associated with trading mutual funds as being a source of reluctance to make a move toward ETFs.
One of the biggest issues with using ETFs is how to get around commissions and intraday trading. Invest n Retire, for example, trades directly with the exchanges and therefore doesn’t incur commissions.
Additionally, the firm is able to purchase fractional shares of the funds — something that is crucial for retirement savers who invest fixed dollar amounts regularly — by holding some cash on hand.
“These are non-issues now,” Mr. Abrahamson said.
Other options include brokerage windows, the most expensive alternative, and collective investment trusts, which create a fund of either a basket of ETFs or just a single such offering. Investors don’t own the ETFs outright; they own merely a share of the
trust.
Trading ETFs directly still is being worked out, but even that hurdle soon could be overcome.
‘Reality set in’
Still, some see barriers to entry.
“Two years ago, I was really excited about ETFs in 401(k)s,” said Fred Barstein, chief executive of 401kExchange Inc., a Lake Worth, Fla., 401(k) service provider focusing on small and midsize companies. “But then reality set in.”
Plan sponsors haven’t clamored for ETFs, because of the difficulty of making the trading work, Mr. Barstein said. Advisers who help the sponsors design their offerings, meanwhile, haven’t suggested the investments.
“From the incumbent’s point of view, they’re not going to push ETFs,” Mr. Barstein said.
“The advisers can either design a plan with ETFs or their own proprietary funds. Which one do you think they’ll choose?” he said.
One place where ETFs could make inroads is in asset allocation funds, Mr. Barstein said. Because of the Pension Protection Act’s recommendation to offer these types of accounts instead of stable-value or money market accounts as the default option, asset allocation funds are likely to see a deluge of new money.
“ETFs are wonderful building blocks inside the asset allocation funds,” Mr. Barstein said. “It’s not so much the move to ETFs as it’s the move toward asset allocation funds.”
