Running the Fund | Published in March 2012

Changing Plans

Will a market emerge for an all-ETF 401(k) plan lineup?

By Judy Ward | March 2012
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Illustration by Steve Wacksman

“We see ETFs,maybe four or five years down the road, as a dominant player in the 401(k) space,” says Steve Anderson, head of retirement plan services at Charles Schwab Corp.

For that to happen, ETFs first have to move onto more mainstream recordkeeping platforms. Schwab took a step in that direction January 10 as it announced a new 401(k) plan lineup consisting of index mutual funds, and said it also plans to introduce an all-ETF 401(k) index-based lineup in 2013.

Up to now, sponsors and advisers have been slow to embrace ETFs in 401(k) plans. According to the 2011 PLANSPONSOR DC Survey, only 1% of plan sponsors say they include ETFs in their fund lineups.

Adviser Michele Suriano looked at putting ETFs in one client’s plan about a year and a half ago, but found what she considered better mutual funds in the asset classes involved, such as international small-cap equity. She did, however, like ETFs’ potentially reduced cost ratios, and passive investing appealed to the sponsor. She has not worked with any client to put together an all-ETF 401(k) lineup yet, but keeps an open mind. “I want to wait until we get participant fee disclosure, and see how ETFs do on trading costs,” says Suriano, president of Colorado-based Castle Rock Investment Co.

The Appeal of ETFs 

Directly offering all-ETF 401(k) lineups to participants is in its infancy, but many advisers already use all-ETF lineups to build customized portfolios for investment options such as target-date funds and target-risk funds in mid-size to large plans, says Chip Castille, a managing director at BlackRock Inc. and head of its defined contribution unit.

Unlike mutual funds, ETF assets coming from 401(k) plans can be difficult to track, BlackRock says. The company estimates it has $6 billion to $7 billion of 401(k) assets under management in its iShares ETFs, including $2.7 billion in net new assets over the past three years, the vast majority of which are from adviser-built model portfolios. “Certainly, we are further down the road in model-builders’ ability to use the tools,” Castille says, “but offering direct access seems to be catching up.” Sponsors like the pure asset-class exposure, lack of style drift, low cost and fee transparency, and access to asset classes that can be difficult to get via mutual funds, such as commodities and emerging markets, he says.

Directly offering all-ETF 401(k)s on recordkeeping platforms brings those benefits to the smaller-plan marketplace, Castille says, referring to plans with less than $10 million in assets. “For some platforms, they are an efficient way to offer index exposure for plans that might not otherwise qualify for institutional-fund pricing or collective funds,” he says.

With fees about to get a big spotlight, ETFs have their best 401(k) growth potential in a while. “The fee-disclosure regulation that is coming is going to be a boon for ETFs,” says Ary Rosenbaum, managing attorney at Garden City, New York-based The Rosenbaum Law Firm P.C. “Most plan sponsors just believe that, if they are given the disclosure, that is it but, as a plan sponsor, you need to make sure that the fees are reasonable.” That means exploring reasonably priced alternatives. “If you are just going to stick [fee disclosure] in a drawer, you are setting yourself up for trouble,” he says.

An all-ETF platform lineup has a couple of major advantages for sponsors, says Neil Plein, vice president of sales and marketing at Invest n Retire, LLC, which already offers an ETF platform for 401(k) plans. He recently wrote a white paper called “401K Manifesto—The New Standard,” arguing for all-ETF lineups. In an interview, he points to an academic study that found 2,100 actively managed mutual funds underperformed their benchmark indices 99.4% of the time over 31 years. For plans gravitating to passive options, he says ETFs average 40% lower costs than index mutual funds. “ETFs do not have any hidden fees; there is no revenue sharing,” he says.