Still Potential for Growth of ETF Use in 401(k)s

The use of ETFs in 401(k) plans has been slow to catch on, but some still believe it will happen.

Chuck Self, chief investment officer and chief operating officer at iSectors LLC, an exchange-traded fund (ETF) strategist that provides model portfolios to 401(k) plans, admits that ETFs remain a small portion of the overall defined contribution (DC) investing pool, but he is optimistic about the future of the product class among retirement investors—especially those working with specialist advisers.

“The whole idea of getting ETFs into 401(k) plans was purely a conversation until a few recordkeepers actually started to allow ETFs to be choices on their platforms,” he tells PLANSPONSOR. “It is a relatively recent event that has occurred in just the past few years.”

He says iSectors is closely involved in the ongoing rollout. Currently the company offers a variety of 14 allocation models to advisers and their clients, which Self personally oversees.

The company recently announced a partnership with Alta Trust, through which it established a collective investment fund (CIF) series utilizing active asset allocation and low-cost index ETFs. Using the CIFs structure is one way to get around some of the limitations of many recordkeeping platforms used by retirement plans, Self notes, which may not be able to handle ETFs.

Charles Schwab has made progress introducing ETFs to both retail investors and retirement plan clients. In September 2014, Schwab transitioned the first 401(k) plan to the ETF version of the Schwab Index Advantage platform. That same month, it also added 60 ETFs to Schwab ETF OneSource, which was launched in February 2013 and offers retirement plan investors access to commission-free ETFs.

As of August 31, 2014, Schwab says its ETF OneSource platform has $31 billion in assets under management, and year-to-date flows into ETFs in the program were $5.9 billion, representing about 45% of the total ETF flows at Schwab.

Self predicts Schwab and others will have slow but steady success boosting use of ETFs among retirement investors. But, he feels more and more advisers “are starting to believe in the potential of ETFs.”

Self notes that most people just don’t have the ability, the time or the interest to put together portfolios to serve their needs and goals. He says this is true for plans relying on mutual funds, ETFs or any other investment structure.

“There is certainly some inertia to overcome—both among the sponsor and adviser communities—which is part of why it is taking a while to boost ETF popularity in this space,” he says. “As you know, the way most 401(k)s are set up, the plan investment committee is made up of people who don’t review investments as their regular daytime job. So the thinking tends to be something like, ‘If people aren’t complaining and they’re not threatening to sue the plan, we better just keep doing what we’ve been doing.’

“It’s a problem in which the incentive to do the right thing—to have the lowest costs possible and to really ensure the plan can drive true retirement readiness—has not been firmly established yet among many of the employers and sponsors that are out there,” Self concludes. “The complaining from participants often doesn’t come until someone reaches retirement age and realizes, hey, I don’t have enough money in the 401(k) to fund a real retirement, what do I do now?”