Exchange-traded funds have generated considerable buzz in the investor community in recent years, as well as substantial return. According to IndexUniverse, ETFs gathered more than $119 billion in net new money in 2011, compared to Morningstar's estimate of a $58.58 billion influx to traditional mutual funds last year.

However, assets in ETFs accounted for only 8% of total net assets managed by investment companies at year-end 2010, according to Investment Company Institute and Strategic Insight Simfund. In employer-sponsored 401(k) plans, mutual funds continue to make up the bulk of portfolios, but as the advantages of ETFs enter the media spotlight, some plan sponsors are integrating them in their 401(k) plan or carving out a brokerage window for savvy participants to freely trade.

ETF fees tend to be lower than traditional open-end mutual fund fees, and the funds are liquid so they can be sold during the day, unlike open-end funds.

Adding to the ETF excitement, Bloomberg recently reported that tech giant Apple will shift its entire retirement plan portfolio to ETFs. According to Apple's Form 5500 filings from 2010, its recordkeeper, Charles Schwab, still is developing a version of Schwab Index Advantage that will use only index-based ETFs. The platform, which would support the intraday trading characteristic of these funds, is expected in 2013.

From buzz to brass tacks

At the end of the day though, more than Apple's endorsement is needed to make ETF-only retirement plans the wave of the future. "The biggest obstacle right now is the administrative support of handling ETFs on recordkeeping platforms," explains Martin Schmidt, a principal with HS2Solutions in Chicago and an advisor with the Institutional Retirement Income Council, adding that ETFs are extremely rare in defined contribution plans, mainly because the industry does yet have adequate technology to support ETF trading.

According to data from the Plan Sponsor Council of America, only 2.7% of companies with more than 5,000 participants had some kind of ETF involved in the composition of their stable-value fund. For smaller plans (with fewer than 5,000 participants), 0.9% of companies used ETFs in target- risk lifestyle-type funds.

Plan sponsors seek to customize investments to a diverse group of participants - whether by age, proximity to retirement or number of assets, among other considerations. Generally, this leads to simpler offerings so that the plan is comprehensible and utilized by a broad employee base. Thus, ETFs may appear incongruous with providing a retirement plan all employees could utilize effectively.

For this reason, coupled with the relative lack of technology to support ETF trading capabilities within DC plans, many employers don't consider ETFs to be a viable investment option at this time.

Nevertheless, employers can work around the obstacles to provide ETF trading abilities to a niche group of their employees using self-directed brokerage accounts.

"The use or availability of brokerage accounts in plans has been growing gradually. If you have individuals at the company who are sophisticated and want to trade, the solution is to provide a brokerage account for them," says David Wray, PSCA president.

Though such brokerage accounts use funds contributed to the 401(k) account and a broker to transact the cost, participants have the freedom to make their own investment decisions, which could include ETFs.

"This money is still in a trust and still underneath the 401(k) umbrella; it's just that this one area is not supervised by the plan sponsor. The participant is self-directing this account," explains Wray.

These accounts must have strong disclaimers alerting the participant that the employer won't monitor these funds. Basically, "when you're in the brokerage account, you are on your own. And participants are made well aware of that," adds Wray.

These accounts appeal to a highly sophisticated investor and are not widely used. Of the 21% of companies that provide a brokerage window option, only 0.9% of participants are in a brokerage window, according to PSCA. In Wray's experience, these participants are generally highly paid financial people. "It's a very unique group and a small group," he says.

Hence, ETFs remain mostly under the radar for employer-sponsored 401(k) plans. "I haven't seen an outcry for [ETFs in defined contribution plans]," says Caren Bianco, a director in the PricewaterhouseCoopers Human Resource Services retirement practice. "Our [independent clients] don't trade very frequently, and those that do trade very frequently probably shouldn't trade as frequently as they are," she explains.

"401(k) participants are not retail investors," agrees Wray. "Let the small percentage utilize a brokerage window while the rest continue to learn the basics of saving," he says. The majority are not "sophisticated investors and to teach them about ETFs is a daunting project."

He adds that an all-ETF plan could send the wrong message to novice investors.

"Employees are told not to trade. They are told to save on a routine basis into a relatively static asset allocation, rebalance periodically, recognizing duration," Wray says. "ETFs are designed to be traded. Plan sponsors don't want to send a message to their participants that they should be trading in their plans."

Today's unknown, tomorrow's lifecycle fund?

Still, some retirement experts remain convinced that ETFs are primed for a bigger mainstream breakthrough.

"Eventually, the benefits [of ETFs in a DC plan] will overcome the technical issues," says Bill DeRoche, CEO of QuantShares. "As we've seen with lifecycle funds, employers have been helping employees make better decisions with regard to how they invest their assets. [Eventually,] you'll see ETFs become wrapped into a lifecycle fund."

The system developed by Invest n Retire LLC does just that. Plans work with an investment manager who oversees the portfolio through a lifecycle approach, determining financial risk based on age. Clients of the Portland, Ore.-based company auto-default participants into higher risk, moderate or conservative portfolios, and if these individuals are unengaged with the plan, the manager moves them as they age to lesser risk.

"We believe in this lifecycle ETF portfolio over something like a target-date fund because in order for people to plan, they have to accurately grasp concepts like target rate of return. Our system builds a bridge between an individual's investment mix and their retirement income replacement ratio needs, and it maps that information so the individual can come online to our retirement calculator, which is fully integrated with all their personal information," says Neil Plein, vice president of Invest n Retire LLC.

Once online, participants can map their retirement saving status and calculate, based on contribution rates, whether they are on track to reach their retirement goal, and if not, how to get on course.

Plein explains that many investment managers and advisers have roots with a private-client experience, where they actively use ETFs. Logically, he says, it would make sense to apply that knowledge base to corporate clients' portfolios.

"We're strong advocates of ETFs in defined contribution plans because they are substantially lower in cost than the majority of mutual funds that are offered in retirement plans, and they're even lower cost for most plans than the index mutual funds," Plein says.

Schmidt estimates that in two to three years, if companies observe success from large recordkeepers like Charles Schwab, ETFs will be more common in 401(k) plans, though probably not mainstream.

ETFs' progress in the DC retirement space is "definitely something to continuously look at and monitor going forward and to see what the attraction will be two to three years out."