Exchange-traded funds are gaining popularity as a constituent of 401(k) plans, bankers say, and may even stimulate adoption of an all-ETF 401(k) platform.
Ed Mooney, a senior vice president in the wealth advisory group at Bank of New York, said a good argument can be made that ETFs can be part of an intelligently allocated 401(k) plan. And Brad Pope, a business officer in Barclays Global Investors' iShares group, said ETFs in 401(k) plans are a growing trend.
Barclays holds more than half the $226 billion of ETF assets the industry had generated through Dec. 31. And Mr. Pope said, "I've had meetings with large pension consultants like Callan, Watson Wyatt, and Mercer, where ETFs were on the agenda. They said, 'This is the only thing we want to talk about.' "
"An all-ETF core option plan is a good idea, but there are barriers to getting there," he said. Technology poses the greatest challenge for an all-ETF plan because most record keeping platforms were created for traditional mutual funds, not ETFs, he said.
Mr. Mooney said ETFs make a good choice for 401(k) account holders that are interested in intraday trading, though 401(k) plans are not the type of investment vehicle that sees a lot of trading. (Unlike those of mutual funds, the shares of ETFs can be traded during the day at current market prices.)
Though Bank of New York has no definite plan to offer an all-ETF 401(k) platform, he said, it would make sense for banks to look into it. "From the bank's perspective," the main concern would be risk, he said, "and as long as it's supplemented with other investment offerings" it makes sense. "Through asset allocation, you have more of an opportunity to control volatility."
An all-ETF 401(k) plan would work for a 401(k) plan of any size, Mr. Pope said. But the corporations "that will make the move the fastest are those with the highest level of transparency," he said, because fees are more a factor with ETFs than mutual funds. ETF fees are generally higher than those for index mutual funds but lower than those charged by actively managed funds.
The Investment Company Institute, a Washington trade group, said last week that ETF assets grew 50% last year, to $226.2 billion. Barclays Global Investors claimed more than half the total, with $114 billion at Dec. 31. The industrywide asset total was up from $151 billion at the end of 2003, the ICI said in its monthly report. The total was also up from $211.7 billion at the end of November.
The institute said there were 151 ETFs at the end of 2004, up from 119 a year earlier.
Mr. Pope said the interest in ETFs is not related to the mutual fund trading scandals of 2003-04 but has to do with people becoming more educated about investment options. Asked whether ETFs would eventually overtake mutual funds as a 401(k) investment option, he said, "I don't know if we can see total replacement."
"Given the low cost structure of ETFs and given the fact that they help insulate participants from other participant activity, it's an attractive option," Mr. Pope said.
Rick Meigs, the founder and president of 401khelpcenter, a Portland, Ore., provider of 401(k) information, said ETFs are appropriate in a 401(k) plan but will not become dominant. "There was talk that ETFs would replace mutual funds. I doubt that will happen, but there is a place for them," he said.
The 401(k) industry began seeing demand for ETFs last year, Mr. Meigs said, but it is not overwhelming. Regarding banks' prospectively offering all-ETF 401(k)s, he said, "it would be early in the market cycle if they did. I would not discourage anyone from offering it, but they should explore it and do their market research."
"May of last year it looked like ETFs would make some inroads," Mr. Meigs said, but they are far from driving mutual funds from the 401(k) field.
Banneker Capital Management Corp., an investment advisory firm specializing in small-cap growth equity portfolio management recently launched a bundled, all-ETF, managed 401(k) plan with BenefitStreet, a third-party administrator. The Banneker ETF Advantage 401(k) Portfolios offer plan sponsors the opportunity to select lifestyle funds for their retirement plan offerings.
Ken Weida, a senior vice president at BenefitStreet, said the company is targeting 401(k) plans with $1 million of assets and up.
An all-ETF 401(k) plan makes sense for banks to offer, he said. "We have half a dozen banking relationships right now," he said, though declining to name the banks.
Mr. Weida predicted that his product will become popular this year but will not affect the popularity of mutual funds in 401(k) plans. "There will be more diversification of stocks, mutual funds and ETFs - as long as the cost stays low - but mutual funds will not disappear from plans," he said. "Participants will have portfolio investing" as in a managed account.
Banneker Capital will supply all the investment management services as part of the platform, and BenefitStreet will supply the back-office and technology-support functions.
Darwin Abrahamson, the founder of Invest n Retire, a Portland, Ore., record keeper, said he sees huge demand for an all-ETF 401(k) plan. "Plan sponsors are becoming very aware that they need to look at and reduce the cost. Anywhere from 70% to 90% of the plan's cost is in the investment options," he said, and Invest n Retire could get the cost down to 20-25 basis points.
ETFs in 401(k)s are also gaining popularity because the Department of Labor, in its capacity as a retirement plan regulator, "is making a big push on fees and because of what has been going on with the mutual fund late-trading scandals," said Mr. Abrahamson. "More plans are looking at the fund families that have been involved" in the scandals, he said, and they are looking for safer alternatives.
"From a fiduciary point of view, we can lower the fiduciary liability because our investment options are the benchmarks," he said, almost like index funds. "You don't have to worry about scandals or style drift."
Mr. Abrahamson, by contrast with BenefitStreet's Mr. Weida, said that the all-ETF model is not cost-efficient for small plans, so Invest n Retire targets plans with a minimum of $3 million. "We started offering the plan [this month], and we are up to 12 plans. Our largest has more than $1 billion in assets," he said.
Invest n Retire would love to work with banks because of their large client base, said Mr. Abrahamson. His company offers the Barclays iShares ETF product as a nonproprietary option.
Mutual funds will slowly disappear from 401(k) plans, Mr. Abrahamson asserted. "ETFs are just too good an investment option," he said. "More and more money will pour into ETFs. It's an instrument that could change the scope of investing" in 401(k)s.
Geoff Bobroff, an asset management consultant in East Greenwich, R.I., said ETFs are an interesting mixing ingredient in a 401(k) plan but requires a brokerage platform to integrate it. "If you or I were trying to construct a $100,000 account, you may like that ingredient," he said regarding ETFs.
Though ETFs have gained in popularity, he said, he does not expect them to replace mutual funds or become dominant in 401(k) plans.
