New Platforms Support ETFs
Exchange-traded fund (ETF) assets have seen explosive growth in the past decade. In the U.S., assets in these low-cost investments jumped from $716 billion in 2008 to $5.02 trillion last year, according to Statista, a provider of statistics, consumer survey results and industry studies.
Still, this is not reflected in the institutional retirement plan space, despite an industry focus on lowering investment and retirement plan costs, experts say. A mere 13% of plans offer ETFs in their investment lineup, according to the 2018 PLANSPONSOR Defined Contribution (DC) Benchmarking Report.
One of the first issues to tackle, when plan sponsors ask about possibly adopting these funds is access. Brian Kraus, head of investment consulting and internal sales at Hartford Funds, in Wayne, Pennsylvania, says the recordkeeping infrastructure that was built mainly to support end-of-day net asset values (NAVs) for mutual funds is a major impediment to the adoption of ETFs in retirement plans. “T[hat] was effectively designed prior to the launch of ETFs,” he says. “It was not set up for some of the schematics of ETFs, so I would say there are more head winds than tail winds.”
Global X, an ETF provider in New York City, has a few clients that manage money on behalf of retirement plans, says Rohan Reddy, a research analyst with the firm. However, most of the interest is coming from international pension funds, rather than U.S.-based pensions or retirement plans, he says.
“The biggest hesitancy to offering ETFs in a retirement plan is that ETF trading can be difficult to manage,” Reddy says.
In addition, there are transaction costs ranging up to $10 when trading ETFs, whereas mutual funds typically do not carry such charges, notes Andrew Windsor, a retirement investment consultant with Unified Trust Co. in Lexington, Kentucky. “Those transaction costs would eat into participants’ returns,” he points out.
Moreover, there would be some trading inefficiencies, as mutual funds trade in fractional shares, whereas ETFs are priced at whole shares, Windsor continues. So, for example, if a retirement plan participant wants to invest $100 but his chosen ETF is priced at $125, his trade will wait for the next contribution, Windsor says. “Cash would be set aside before being invested,” he notes. This is true for all ETFs regardless of the platform, he says. However, some get around this by trading the ETFs at the plan level, where they can aggregate trades, Windsor says.
Kip Meadows, CEO of Nottingham in Rocky Mount, North Carolina, says that while most recordkeeping platforms can handle only mutual funds, Vestwell and Betterment are two platforms recently launched with an express interest in offering ETFs. In fact, Nottingham’s own retirement plan has ETFs in the lineup because the firm is interested in offering participants exposure to niche sections of the market that some ETFs track—specifically “different parts of the economy, different geographic areas of the world and different industries,” Meadows says. As a trustee, he says, he is unconcerned about offering exposure to niche markets, but, as a fiduciary, he would worry about holdings of more than 10% in any one niche market.
“If you want to be diversified, these solutions make a lot of sense,” Meadows adds. “Now that the ETF market has become mature, as more employers hear from their employees that they want to invest in the funds, their plan administrators will make it happen.”
However, says Kraus, many of the inherent advantages of ETFs are negated in the 401(k) world. “The ability to trade ETFs throughout the day, their tax advantages and their transparency to their underlying holdings are less of an advantage in the defined contribution world, because those accounts are long-term and buy-and-hold driven,” he explains.
Mitch Reiner, chief operating officer (COO) of Capital Investment Advisors in Atlanta, says that, were participants to day-trade ETFs, that would be a major distraction from the real goals of the retirement plan as an employee benefit. And, while the single- or double-digit basis-point expense ratios of ETFs are attractive, retirement plans can often access very low-cost institutional shares of mutual funds, Reiner says. However, he concedes, ETFs could be an appealing option for smaller plans that lack access to the same pricing advantages.
The Vestwell and Betterment platforms, however, find that retirement plans are very interested in offering ETFs. In fact, on the Vestwell platform, the same percentage of assets—49%—are found in ETFs as in mutual funds, the remaining 2% in collective investment trusts (CITs).
Aaron Schumm, CEO of Vestwell, in New York City, specifically wanted to offer ETFs on Vestwell’s platform, which went live last year. He says his reasoning was that they have “become household names and are more liquid and lower cost than mutual funds. Plus, you don’t have to worry about the share class issues you have in the mutual fund world, such as 12b-1 or other back-end revenue-share fees.” The average ETF net expense ratio for an investment program on Vestwell is 20 basis points, versus the average mutual fund net expense ratio of 40 basis points, Schumm says.
Betterment for Business launched its recordkeeping program in 2010, starting off exclusively as an ETF investing platform, says Adam Grealish, director of investing at the firm in New York City. The reason Betterment wanted to offer ETFs is because its platform supports savings goals other than retirement.
“Mutual fund shareholders’ taxes are influenced by redemptions from other shareholders,” he says. “The fund has to sell shares to meet redemptions, which in turn hits investors with capital gains. ETF shares, on the other hand, are bought and sold on the secondary market.”
Additionally, Grealish says, Betterment helps participants “set their retirement target amount and advises them on how much they need to save and what level of risk to take to achieve that goal.”
The firm also purposefully decided to build its platform around ETFs because “other service providers have proprietary funds that sometimes include revenue-sharing fees,” says Amy Ouellette, director of retirement services at Betterment, also in New York, although she notes that R6 share classes are growing. That said, Ouellette observes that funds with revenue sharing “have inherent conflicts of interest and are opaque.”
According to Reddy, as defined contribution and defined benefit (DB) plan sponsors in the U.S. begin to understand the funds’ advantages and take the cue from international pension plans, “ETFs in retirement plans will become one of the biggest areas of growth” for the exchange-traded fund industry. “As many actively managed mutual funds have underperformed, benchmark tracking in a more liquid manner that doesn’t generate capital gains is going to become a lot more important,” he says.
Additionally, “as fee compression continues, access to markets at a lower price will make ETFs all the more attractive to” retirement plan sponsors and participants alike, Reddy says.
Art by David Jien