In an environment of transparency and volatile capital markets, you would think exchange-traded fund vehicles would hold more of a percentage in the $3.6 trillion retirement plan marketplace.
Well, you thought wrong.
Estimates from Cerulli Associates' Exchange-Traded Fund Markets 2013 report highlight that ETFs made up just 0.2% or $6 billion of overall 401(k) assets as of 2011 compared to the $1.6 trillion of mutual fund assets held in defined contribution plan investments.
"401(k) and DC plans were made for mutual funds, the way they work fits the mutual fund," saidAlec Papazian, associate director in the global analytics firm's asset management practice. He added that "If ETFs are going to become essential to investing as mutual funds are, then retirement plans will have to be a part of that discussion."
The ease of end-of-day trading is heralded by the now $2.7 trillion money market mutual fund industry. But ETFs, a nearly 20-year-old market, have been touted as a product that can buy and sell positions at various times of the day, therefore preventing risk from market drops.
Stadion Money Management is one firm that has seemed to crack the ETF puzzle. Founded in 1993, around the same period ETFs sprang onto the scene, the Athens, Ga.-based firm presently manages about $3.6 billion in retirement plan assets.
Tim McCabe, a senior vice president and head of Stadion Retirement, says 90% of its assets under management fall within ETFs and cash products.
"For us, as an active investment manager, ETFs were a godsend really because the fact that it gave us the ability to buy these positions...and potentially sell them at optimal times," McCabe said.
But as a standalone vehicle, McCabe agrees that some challenges are ahead. "...It [ETF] doesn't fit into the traditional mutual fund centric record keeping system, where the majority of assets are housed in the retirement industry," McCabe said. "...But there have been some innovations basically buying in over the course of the day and giving you average course of the day daily pricing."
Ultimately, "it's a more efficient vehicle, and at the end of the day, faster, better, cheaper usually wins out," he noted.
Recent developments point to attraction from one of the retirement plan investment industry's biggest players: Fidelity Investments.
On May 14, Fidelity Investments confirmed it received the green light to open its own actively managed ETF platform from the Securities and Exchange Commission. The financial services juggernaut, with over $4.2 trillion in assets under administration of investment and retirement plan assets, would not disclose its future strategy just yet.
Fidelity spokesperson Jeff Cathie said the firm will continue "to evaluate the product needs of our clients and it would be premature to discuss our product plans, including the types of ETFs we may manage and when we may introduce."
Since its birth, ETFs have grown from a measly $464 million in total assets to breaking the $1 trillion marker in 2011, according Investment Company Institute data. At the end of April, ICI says the products' value rose by nearly 23.7% over the past 12 months to $1.46 trillion.
One prospect to this increased growth is back-end trading services provided by behind-the-scenes players such as Denver, Co.-based Matrix Financial Solutions, a fund settlement platform that administers trades for the likes of some of the largest asset management companies.
Cynthia Dash, chief operating officer at Matrix, said that the company has more than $430 million in ETF assets under administration. There are around 1,100 ETFs on the 16-year-old firm's platform, which began trading the vehicle in January 2010.
As an intermediary firm, its total offering is around $200 billion in assets under administration.
"We have certainly seen the growth on our platform, which leads us to believe that in this environment where there is so much emphasis on expenses, and taking out those conflicts of interests, ETFs are certainly becoming an important part of retirement plan strategy," said Dash.
Matrix's platform utilizes a process that captures the variable daily prices of ETFs by taking on a "T+1" settlement perspective, which allows for fractional shares to be balanced over each trade, Dash said.
After purchase or sale of a security, "T+1" or "trade date plus one day" settlements must be realized by brokerage firms over that one day period.
"We've made that look and feel like a '40 Act' mutual fund," Matrix President John Moody said. "We've cleaned up the process."
On the retail side, Charles Schwab & Co., a firm with more than $2 trillion in client assets and more than 1.6 million corporate retirement plan participants, is in the running to rectify the system's problem inherent in the vehicle's usage.
In February, Schwab Retirement Plan Services announced that its "one-of-a-kind 401(k) plan," the Schwab Index Advantage, is looking to add index-based ETFs to its available menu of investment products.
"Fund operating expenses are often lower than those of index mutual funds," Steve Anderson, executive vice president of Schwab Retirement Plan Services, said previously. "We believe integrating ETFs into a 401(k) lineup can drive costs down further and provide workers with the opportunity to save even more for retirement."
When asked about future plans regarding the look and feel of the index ETF package, Charles Schwab spokesperson Mike Peterson noted last month that it "will enable plans and participants to trade ETFs intraday, as ETFs are intended to be traded.
"We believe this is a significant advantage/distinction compared to the limited ETF solutions in 401(k)s today that only offer trading at end of day like mutual funds," Peterson added.
On a wider basis, the Schwab effort has caught the eye of many industry onlookers. Papazian is waiting to see how Schwab's program is rolled out. Over the next 5-10 year period, he estimates that some of the major problems facing ETF reconciliation, which include cracking the recordkeeping technology issue and getting penetration among plan participants, will make some positive headway.
But right now, the Cerulli Associates director believes "the hurdles are too high."
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