Is DC Market Showing More Love for ETFs?

Recent Cerulli data shows robust ETF asset growth across various retail and distribution channels, except in one area: private defined contribution (DC) plans, according to the October issue of “The Cerulli Edge – U.S. Monthly Product Trends Edition,” which examines institutional product use.

Historically, ETFs were not used in 401(k) plans, Cerulli says, because the very characteristics—intra-day trading, tax advantages and low costs—that make them appealing are either irrelevant or questionable when considered in the context of a DC plan.

For larger plan sponsors with access to institutional shares of index mutual funds, the value-add of ETFs is immaterial, Cerulli contends, because institutional class shares of mutual funds’ expense ratios are often even more competitive than ETFs. If investors are seeking passive exposure, index mutual funds may be more suitable than index ETFs as they have the potential to incur expensive trading costs relative to mutual funds.

Mutual funds continue to be the most common investment vehicle within 401(k) plans, and collective trusts a distant second. ETFs make up just a fraction of a percent (0.02%) of the investment vehicles used in 401(k) plans.

But ETFs might be gaining wider acceptance. According the 2015 Plan Benchmarking Report from PLANSPONSOR, overall, 7.1% of DC plans use ETFs outside of brokerage windows, a substantial increase from the previous year’s 3.7% of plans. Plans with less than $1 million in assets have the highest uptake at 12%, a gain of five percentage points from the previous survey, and plans with $500 million to $1 billion have the lowest (2.1%). The largest increase in usage comes from plans with $1 million to $5 million in assets, rising from 2.2% to 9.7%.

A few firms have begun offering ETFs to the DC market. In 2014, Schwab rolled out the Schwab Index Advantage 401(k) ETF platform. It comprises approximately 80 ETFs, a combination of Schwab proprietary ETFs and those from other sponsors, including PIMCO, Van Eck and PowerShares.

The platform has grown to more than 120 plan sponsors. Schwab also offers a managed account advisory service within the Index Advantage platform, which has ongoing investment management based on a variety of factors, including an employee's age, income, account balance, and savings rate in his or her 401(k) plan.    

Considering the vast size of the DC marketplace, though, Schwab’s success has been minimal. At more than $5 trillion as of year-end 2014, the pool of DC assets is one of the largest within the institutional channel. Based on the size of that asset pool, Cerulli believes the amount of recent media attention to ETFs within the context of the 401(k) space is outsized with respect to their marketshare and potential use.

Cerulli’s survey shows more ETF sponsors are focusing distribution efforts on small- and mid-sized defined contribution (DC) plans, with assets less than $250 million. Then, too, the market for automated online advice or robo services is also boosting efforts to bring ETFs to DC plans.

As more eRIA firms enter the market using ETFs as a primary investment, adoption in 401(k) plans could be in the foreseeable future. However, given ETFs’ current marketshare in the DC space, any meaningful impact is still a ways off. The concept of bringing ETFs into 401(k) plans through online advice service may be the next trend that will further catapult ETF growth, which has the ears of sponsors ringing. Cerulli believes true success will stem from support and awareness from recordkeepers to offer ETFs to plan sponsors.

More information about “The Cerulli Edge - U.S. Monthly Product Trends Edition, October 2015” is available on their website.