ETFs or exchange traded funds offer an inexpensive investment with greater transparency than traditional mutual funds using passive strategies that have been wildly popular for individual investors, especially high net investors. So why haven’t they become popular in 401k plans?
Let’s start with the overwhelming benefits of Exchange Traded Funds which include:
- Low cost index strategies which is growing at the expense of active management.
- No revenue sharing embedded making them even less expensive.
- More transparent pricing as they trade every few seconds like stocks rather than end of day pricing used by mutual funds and CITs (collective trusts).
By the end of 2014, ICI estimated that ETFs have 13% of pooled investments like mutual funds and CITs. So why are they so hard to find in 401k plans?
ETFs are used as building blocks within many professionally managed investments like target date funds so they are part of the 401k eco-system – it’s just hard to find them as a solo investment. Charles Schwab announced an all ETF 401k program a few years ago to great fanfare but with muted results. Many robo-advisors are employing an all ETF strategy.
The problem is technology. 401k and 403b record keeping systems, most of which were designed decades ago, were built to make small trades for relatively small accounts cost efficiently once a day called omnibus trading. Mutual funds priced daily fit the bill perfectly but not ETFs which are repriced every 13 seconds and take three days to settle a trade meaning retirement investors have to wait to get their money while the price changes.
There are new systems being built that work more like a brokerage account which ETFs can be accessed today, and legacy omnibus record keeping systems have manufactured work arounds for ETFs.
Some critics of ETFs say that intra-day trading in not needed and actually should be discouraged and that index funds are just as good with lower costs and less revenue sharing than with active funds. And while revenue sharing may be replaced some day by charging each participant an equal fee based on the size of their account, not which investment they select, until then, the use of ETFs will cause plan sponsors to either subsidize the cost of running the plan or charge participants not using ETFs more. Stay tuned.
