Thursday, September 13, 2007

ETFs try to elbow into 401(k)s

ETFs are attempting to make their way into 401(k) plans (free WSJ Digg link), a move that the mutual fund industry is pushing back on. According to the story, 14% of total mutual-fund money is 401(k) accounts, while only 1% of ETF money is in 401(k) accounts. Total mutual-fund assets are $1.49 trillion, while total ETF assets are $500 billion. The arguments the two sides are making are:

ETF providers blame mutual-fund companies, some which run some of the biggest 401(k) plans, saying their resistance stems from fear of competition. ETFs in general charge lower fees than average mutual funds.

Mutual-fund purveyors see it differently. They say that they already offer plenty of low-cost mutual funds that track stock- and bond-market indexes as most ETFs do, and that some of the most heavily touted features of ETFs, such as tax efficiency and flexible intraday trading, offer few advantages in 401(k) plans, which already are tax-advantaged and geared toward long-term investing.

The other challenge is the need to develop trading platforms to trade the ETFs in 401(k) accounts.
The logistics of offering ETFs also complicate things: ETFs can be bought and sold on exchanges like stocks, but most 401(k) programs aren't set up to process the trades. And because they trade like stocks, ETFs charge commissions -- costs that can diminish the returns of workers who make small, regular contributions to their retirement accounts.


To gain a foothold, many ETF providers are either building computerized "platforms" to support trading of ETFs within 401(k) plans or forming partnerships with companies that are. Some firms are devising solutions to minimize ETF trading commissions -- aggregating trades across investor portfolios, for example, to limit the role of stockbrokers and other middlemen.


Firms like BenefitStreet are trying to narrow that gap. The San Ramon, Calif., company, which runs about $8 billion in retirement money for more than 7,100 plans, started offering ETFs from Barclays Global Investors and others in June on a 401(k) platform it sells to client companies. Its approach involves aggregating ETF trades among, say, hundreds or thousands of employees, to diffuse commission costs. It eventually aims to send trades directly to stock exchanges, bypassing floor brokers.

Another small firm, Invest n Retire LLC in Portland, Ore., already trades directly with exchanges and has a patent pending on the method. Rather than bundle the trades, Invest n Retire processes them throughout the day with an automated system that executes them for a few cents a share. RPG Consultants of New York offers a system that places orders to brokers in bulk daily to help keep costs low.

Admittedly, I don't know all the details of how these systems work, but the aggregation and bundling of trades concerns me. One of the great advantages of ETFs is the ability to trade them like stocks, with near real-time execution of the trades. Another is the ability to put limit orders on ETF trades. Anything which would diminish these capabilities, which is what this aggregation and bundling sounds like it would do. I would suggest enhancing the individual stock trading capabilites already in some 401(k) plans to add ETF trading.

The story has some good nuggets of information about the retirement plan industry:
The plans held an estimated $2.7 trillion at the end of 2006, representing about 17% of the overall U.S. retirement market, according to the Investment Company Institute, a mutual-fund industry trade group. (About half of retirement money is held in defined-contribution plans, which include 401(k)s, and in individual retirement accounts, according to the ICI. The other half is in government pension and private-sector defined-benefit plans, as well as annuities.)

Just over half of the money in 401(k) plans was invested in mutual funds as of the end of last year, ICI statistics show, followed by investments in products offered by insurance companies, banks and other institutions.

The $1.49 trillion of mutual-fund money in 401(k) accounts represented about 14% of total mutual-fund assets in the U.S. at the end of last year. While assets in ETFs have more than quintupled to about $500 billion since 2002, less than 1% of 401(k) money is estimated to be in the products.