Charles Schwab is giving their 401(k) offering a makeover.
The firm is adding a long-awaited 401(k) platform that will allow participants to invest all of their plan in low-cost ETFs, signifying a desire to capitalize on the ETF growth story. .
Steve Anderson, head of Schwab Retirement Plan Services, which has about $105 billion in assets and 1.3 million participants, estimates a 401(k) plan using ETFs can reduce investment expenses by more than 90% compared to a typical 401(k) plan that primarily uses actively managed mutual funds, and by more than 30% compared to a 401(k) plan that uses index mutual funds.
Implications for Fund Managers
Vanguard's Joel Dickson notes that from a fund provider perspective, an all-ETF 401(k) platform isn't new in that "ETFs are simply a wrapper for an index strategy and we've been offering that for years," he says.
The most obvious implication of Schwab's offering for ETF managers, however, is a potential flood of fresh assets into the industry that would accelerate downward pressure on fees. "As index funds and ETFs get larger fees get smaller - tapping into new source of assets could help accelerate that," says Morningstar's Ben Johnson.
The new platform may also make headway for other ETF players in the 401(k) industry - one that has until now been largely dominated by mutual funds, Johnson says. After all, mutual funds still hold significantly more in assets - a total of $15 trillion at the end of 2013. ETFs, however, are a stronger growth opportunity for fund companies, Johnson says.
As of now, Charles Schwab's platform spans all 14 Morningstar asset-class categories from major providers including Charles Schwab Investment Management, ETF Securities, First Trust, Guggenheim Investments, Invesco PowerShares, iShares ETFs, PIMCO, State Street Global Advisors, Van Eck Global, Vanguard and United States Commodity Funds. "Despite the ... benefits of ETFs, mutual fund companies that dominate the 401(k) industry have largely ignored them - simply because these companies lack either the capabilities or the will to effectively accommodate exchange-traded funds in the retirement plans they offer," Anderson explains in a statement from the firm.
Charles Schwab's platform follows a similar move by TD Ameritrade, which began offering ETFs in 401(k)s in March 2011. The differences? Schwab offers intraday trading of ETFs on the plan's core investment menu; TD Ameritrade offers end-of-day trading. "The reason for that is that 1) no plan sponsor has ever asked us for intra-day trading, in fact they want to avoid that kind of activity by their employee; and 2) we can aggregate all orders during a trading day and get better executions end-of-day," says Skip Schweiss of TD Ameritrade.
Another difference: Schwab markets its offering directly to plan sponsors; TD Ameritrade markets theirs to financial advisors. "We exist to support advisors, to provide them with the tools to succeed, not to compete against them," Schweiss explains. Schwab offers ETFs from 11 providers, including proprietary funds, while TD Ameritrade does not offer proprietary funds.
Finally, Schwab offers 80 ETFs. TD Ameritrade, meanwhile, offers 1,000.
Riding on Growth, Mutual Fund Dominance
The entry by TD Ameritrade and now Charles Schwab into the ETF 401(k) market rides on the heels of tremendous ETF industry growth and popularity. Assets in ETFs have grown from $66 billion in 2000 to more than $1.6 trillion at the end of 2013, according to the Investment Company Institute. "The notion by some industry commentators that these benefits should not be available to 401(k) participants reminds me of the proponents of gas lighting who, 100 years ago, argued that electricity was dangerous and unnecessary," Anderson states. Critics of ETFs in 401(k) portfolios also suggest that introducing these investment vehicles into retirement plans will lead to over-active trading within 401(k) portfolios, which fund managers say are meant to be pools of assets that are best left largely untouched for the long-haul.
To the assertion that ETFs may be inappropriate for 401(k) plans, Anderson responds in a statement: "We heard the same false argument 25 years ago when the industry began updating participant 401(k) balances on a daily basis, instead of quarterly." Fund managers note that as long as ETFs are held for the long term in 401(k) portfolios, investors will benefit, so it is incumbent for plan sponsors to select appropriate ETFs.
"At the end of the day - whether or not investors trade - providers will benefit from fund flows," Johnson says.