New regulations spur cheaper 401(k) options

As advisers to 401(k) plans brace for upcoming regulations mandating greater fee disclosure, The Charles Schwab Corp., BlackRock Inc. and TD Ameritrade Trust Co. are among a number of firms that are launching lower-cost options ranging from exchange-traded funds to index-fund-only plans

As advisers to 401(k) plans brace for upcoming regulations mandating greater fee disclosure, The Charles Schwab Corp., BlackRock Inc. and TD Ameritrade Trust Co. are among a number of firms that are launching lower-cost options ranging from exchange-traded funds to index-fund-only plans.

Starting Jan. 1, 401(k) plan vendors will have to start disclosing their fees to plan sponsors, and the latter will have to start disclosing fees to plan participants.

The increased disclosure will mean that advisers who service the 401(k) market will be under more pressure to justify the cost of their plans. In many cases, advisers will turn to lower-cost investment options, such as index funds and ETFs, to help protect their own margins, industry observers said.

“Ultimately, there is going to be fee compression, and that’s going to hit advisers,” said Ryan Alfred, co-founder of BrightScope Inc., which rates plans. “So firms like Schwab are trying to partner with advisers so that the advisers can still make 25 to 45 basis points on 401(k) plans, with costs that won’t be too high [for the plan participants].”

The average domestic-equity index fund has net expenses of 0.89%, compared with an actively managed domestic-equity fund, which has net expenses of 1.35%, according to Morningstar Inc. The average domestic-equity ETF has a net expense ratio of 0.52%.

Lower-cost passively managed funds have been successful in the large-plan market, or those plans with more than $100 million in assets, for some time, according to BrightScope. Between 2007 and 2009, there was 125% growth in plans with large-cap-equity index funds, BrightScope said.

SMALLER PLANS

Now smaller plans, which often use advisers, are looking increasingly for lower-cost options, particularly with new regulations looming.

For example, last year The Vanguard Group Inc.’s funds surpassed American Funds as the most widely held fund family on TD Ameritrade Institutional’s retirement platform, breaking a 15-year trend, said Skip Schweiss, president of TD Ameritrade Trust Co.

“One thing they are looking at is, “How much am I spending on investment management?’” said Steve Utkus, the head of the Center for Retirement Research at Vanguard. “And the easiest way to [reduce] that is to move from active funds to passive funds.”

To address this, Schwab this year will launch a 401(k) plan using all index funds. Next year, the firm will roll out an ETF-only plan.

The new plans will reduce participant costs by 35% to 85%, according to a presentation made last month by Schwab chief executive Walt Bettinger.

The plans, which Schwab will offer with personalized advice for participants, can complement advisers’ efforts in this area, said Greg Gable, a Schwab spokesman.

“Their skills in investment advice, including fund selection, portfolio construction, ongoing monitoring and re-balancing, are nicely aligned with what we know to be a key driver in getting employees to and through retirement, and that’s quality personalized advice,” he said.

The plans’ lower costs also “align well with their fiduciary approach,” Mr. Gable said. He declined to comment about which funds and ETFs would be in the two plans and how much they would cost.

Another way that firms are working to get lower-cost index funds into 401(k) plans is by making them the underlying investments in target date funds. This month, BlackRock filed with the Securities and Exchange Commission to launch funds of that type, joining Fidelity Investments, Vanguard and TIAA-CREF, all of have similar offerings.

“With the increased scrutiny on transparency and fees, passive funds make a lot of sense for defined-contribution plans,” said Chip Castille, head of the defined-contribution business at BlackRock.

He declined to comment about the filings.

BlackRock also makes its ETFs available to 401(k) plans and so far has 100 platforms using them, most of which have less than $55 million in assets, he said.

Similarly, last month, TD Ameritrade added ETFs to its retirement platform for advisers.

‘SLICING AND DICING’

“We did this in response to demand, because advisers like slicing and dicing the index exposure, and costs are obviously a factor,” Mr. Castile said.

So far, the platform has 200 ETFs.

Although advisers like the idea of having ETFs or index funds in their 401(k) plans, some aren’t sure that they would choose an all-index plan or all-ETF plan such as the ones Schwab is planning for their clients.

“Cost is always a component, but if an active manager can add 60 basis points of value over time, then that manager is worth it,” said Tom Clark, president of Lockton Retirement Group LLC. “I don’t think there is an appetite for a one-size-fits-all as much as giving participants choices.”

E-mail Jessica Toonkel at [email protected].