Despite being known as a low-cost investment—offering access
to many different investment classes and styles—exchange-traded funds (ETFs)
have struggled for years to enter defined contribution (DC) retirement plan
According to 2015 data from Cerulli, mutual funds continue
to be the most common investment vehicle in 401(k) plans, with collective
trusts a distant second. ETFs make up just a fraction of a percent (0.02%) of
the investment vehicles used in 401(k)s.
One reason ETFs have failed to catch on in the DC market is
their intraday trading is incompatible with most defined contribution plan
recordkeeping systems, which were built to accommodate mutual funds, or similar
investment vehicles. Mutual funds trade once per day and are pooled along with
other investors’ trades. ETFs can be traded intraday, have fractional shares
and, therefore, are more liquid.
“In order for folks to adapt to ETFs now, they have to trade
after market or with some kind of roll-up activity, which drives up costs and
takes away the benefit of ETFs,” says Bob Ward, chief revenue officer for
Vertical Management Systems, in Pasadena, California.
However, ETFs may have finally found their point of entry
into the DC market, says Matt Cirillo, senior analyst, retirement, at Strategic
Insight in Boston. ETFs are slowly gaining traction as underlying investments
within other vehicles, such as target-date mutual funds (TDFs). Cirillo says
the trend has been building for the last six to eight years. Some analysts
credit the cost advantages.
According to Strategic Insight data, among the top five TDF
providers, only one uses ETFs as underlying investments, but, among all 39 TDF
providers analyzed, 17 now do so. Still, Cirillo notes, ETFs account for only
approximately 2% of the $861 billion TDF market.
Cirillo says newer entrants and smaller managers are
significantly more likely to include ETFs in their TDF funds, in trying to
combat the scale of larger managers. Using ETFs in this way has not caught on
with established retirement plan investment providers, however, as they have
the capacity to create their own indexed funds and utilize them for core asset