Exchange traded funds provide liquid and low-cost exposure to the broader markets. However, defined contribution, 401(k) plans are not taking the bait.
Executives at 401(k)s larger than $100 million show little interest in ETFs partly because current investment options in defined contribution plans, such as institutional shares of index funds, collective trusts and separate accounts, are as cheap or cheaper than ETFs, writes Robert Steyer for Pensions & Investments. [iShares: The 401(k) State of the Union]
“I don’t see ETFs as a core investment in the foreseeable future,” Robert Benish, executive director and interim president of the Plan Sponsor Council of America, said in the article.
Nevertheless, ETFs have made some inroads into self-directed brokerage accounts. According to Callan Associates, 2.3% of defined contribution plans, with less than $200 million in assets, offered ETFs in 2012 compared to 2.5% in 2011 and zero in 2010. A Cerulli survey found that 401(k) assets made up only 0.2%, or $6 billion, of the $1.05 trillion in ETF assets as of the end of 2011.
“There’s a long road ahead for ETFs in 401(k) plans,” Alec Papazian, associate director at Cerulli Associates, said in the article, adding “there are a lot of administrative complications” that represent “significant hurdles” for ETFs in 401(k) plans.
For instance, 401(k)s are designed for end-of-the-day mutual fund trades, mutual funds can hold fractional shares, and ETF trading fees can diminish cost advantages. Consequently, Papazian believes that the administrative hurdles outweigh the benefits of using ETFs.
“These methods to incorporate ETFs likely come at substantial administrative costs,” according to a Cerulli report on the survey. “A large ETF sponsor expressed that firms will have to come up with a way to offset these expenses similar to 12b-1 fees charged by mutual funds. Otherwise, significant traction in the 401(k) market will not occur.”
However, Charles Schwab is working on an all-ETF program for 401(k)s, similar to the Schwab Index Advantage program. Steven Anderson, executive vice president of Schwab Retirement Plan Services, will offer commission-free ETF trades for 401(k)s with assets ranging from $20 million to $5 billion.
ETFs “will play a more dominant position over time (in DC plans) — but not immediately,” Anderson said.
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Max Chen contributed to this article.