Money Management Executive
In an ideal world, investors would have diverse portfolios of stocks, bonds, mutual funds, exchange-traded funds, and annuities to ensure a comfortable retirement, but the world of retirement planning is far from ideal, and most Americans, if they prepare at all, use one tool: the 401(k) plan.
Critics of such a strategy say that often means access to only one type of product: mutual funds.
“The question is: What is the right combination of tools for a particular investor?” said Jeremy Alexander, the president and chief executive of Beacon Research Publications Inc., an annuity data provider in Evanston, Ill. “The mutual funds think they have the answer. Insurance companies think they have the answer. ETFs think they have the answer. Everyone thinks they have the answer. No one has the answer.”
That is because the answer is a combination of each of these instruments, tailored to the needs of each investor, he said.
But mutual funds remain the only product that can get on most 401(k) platforms, because they are the only product supported by most record-keeping systems.
“These are old, legacy software programs that are 10, 15, or 20 years old,” said Darwin Abrahamson, chief executive of Invest ’n Retire LLC, a Portland, Ore., firm that offers a retirement system designed for exchange-traded funds.
Hartford Financial Services Group Inc., which is best known for its insurance products, says it is working to design its annuity-related Lifetime Income product to complement other investments on 401(k) platforms.
“There is an investment in bringing that record-keeping technology up to date,” said John P. Carbone, managing director with the Simsbury, Conn., company. “It’s a challenge.”
Provisions in the Pension Protection Act of 2006 on automatic plan enrollment and allocation have made breaking into the growing 401(k) market more attractive, but observers say there is no sign record keepers will budge anytime soon.
“I don’t think we’ve seen enough demand from plan sponsors that record keepers are going to figure out a way to get their systems to handle these products,” said Sam Campbell, director of research at Financial Research Corp. of Boston.
Instead of waiting for 401(k) providers to adapt their systems, many investment firms are adapting their products.
For ETFs, the primary problem is that mutual fund-friendly 401(k) platforms, built for once-a-day trading, cannot accommodate products that trade like stocks and price throughout the day.
Companies like Seligman Advisors Inc. of New York sidestep such challenges by creating mutual funds that use ETFs as their only underlying investments.
The Seligman TargETFund, for example, is a target-date mutual fund that uses a mix of ETFs that change as a worker approaches retirement. Because the underlying funds cost investors only 23 to 25 basis points in total, compared with 100 to 200 for their mutual fund-made counterparts, the Seligman fund is less expensive than the typical target date fund, even with its 98-basis-point overlay mutual fund structure.
At Invest ’n Retire, Mr. Abrahamson scrapped the idea of adapting to the old system. Instead, he built his own all-ETF platform. The patent-pending platform allows investors to own ETFs directly, eliminating the fees added through a mutual fund structure.
Gary Gastineau, the principal of ETF Consultants LLC in Summit, N.J., said that with mutual funds, the net asset value rises and falls as investors jump in and out. ETFs, while liquid, require investors to pay their own trading fees, leaving the fund more stable, he said.
Because Invest ’n Retire deals directly with exchanges and trades in high volume, investors dodge some of the trading costs and commissions ETFs would carry if they were to trade for themselves, he said.
Mr. Abrahamson said he believes an increase in awareness about the fees and revenue-sharing agreements mutual funds espouse — amplified by new disclosure regulations from the Department of Labor — will bring ETFs into the 401(k) space soon.
“Corporate executives have not been doing the due diligence,” he said. “Now these [impending] lawsuits are going to make them realize, ‘Hey, we need to do this.’ ”
Unlike the Seligman TargETFund, which features instant allocation, Invest ’n Retire’s program allows investors to choose ETFs for themselves. “We are living longer these days. Participants can no longer afford fixed income when they retire; most still need growth in their portfolios,” Mr. Abrahamson said.
Hartford says it is addressing investors’ concerns about outliving their savings through its 401(k)-ready Lifetime Income product. For every share investors buy, they are assured income of $10 a month from the retirement date chosen for the remainder of their lives.
“Look at it like a different asset class. You’re not accumulating. You’re buying income,” said Patricia Harris, assistant vice president of Hartford’s institutional solutions group.
But for the purposes of getting on a 401(k) platform, the product works a lot like mutual funds, to which investors are already accustomed, according to Hartford. Investors can allocate a portion of their savings for buying shares of the Lifetime Income product, and fractional shares are allowed.
But under the hood, the product looks more like an annuity. However, in the interest of preserving the tax advantage, the sum of the shares does not annuitize until near the date payments are scheduled to start and the price per share varies according to factors like the investor’s age and the inflation rate. That price will continue to change over time.
The product is simple to explain to investors, according to Hartford, but as with income-guarantee products from companies such as Genworth Financial Inc. and MetLife Inc., record keeping has proved to be a major impediment to getting on 401(k) menus.
But with employees constantly hearing about the impending retirement crisis, Mr. Alexander is confident that demand for such products exists. In turn, he predicts, record keepers will respond.
