ETFs Still Missing From 401(k)s

October 01, 2018

[This article appears in our October 2018 issue of ETF Report.]

ETFs may show up in small-sized plans, or if a plan allows a brokerage account, but when it comes to midsize and large plans, ETFs are largely absent. This discrepancy is really a tale of two types of plan sponsors: larger plans and smaller plans that can’t get the institutional pricing offered to larger plans. It’s also a tale of how plans process investments, whether they use new record-keeping technology that makes it easier to use ETFs, or if they still use legacy products.

But even in small plans, ETFs are hard to find. Data from the Plan Sponsor Council of America (PSCA), a nonprofit trade association supporting employer-sponsored retirement plans, show that in plans of any size, ETFs generally represent less than 10% of investment vehicles in the different investment categories available. Mutual funds have the lion’s share of business.

There’s also the fact that some of ETFs’ most touted benefits, their intraday trading and their tax efficiency, are largely irrelevant in all kinds of retirement accounts, which tend to be designed for buy-and-hold strategies and which are tax advantaged. Daily transparency, another much-vaunted advantage that ETFs have over mutual funds is also largely irrelevant to a retirement investor. When your investment horizon is decades long, the requirement for quarterly portfolio disclosure for mutual funds isn’t that offputting. 

Cost & Infrastructure Obstacles
ETFs’ availability in 401(k)s comes down to cost and infrastructure, as the other traditional ETF benefits are mostly unnecessary in 401(k)s. People familiar with ETFs and defined contribution plans say they don’t rule out ETFs ever making inroads into the plans, but they also don’t see these vehicles being among the offerings anytime soon for the bigger plans.

Richard Powers, head of ETF product management in Vanguard’s Portfolio Review department, says ETF costs keep ETFs out of the larger 401(k)s. That might sound surprising, since ETFs’ low costs versus mutual funds are a top ETF selling point when it comes to brokerage accounts.

For example, the popular Vanguard Total Stock Market ETF (VTI) has an expense ratio of 0.4%. Vanguard’s Total Stock Market mutual fund (VTSMX) cost is 0.14% and requires a minimum investment of $3,000. The Admiral Shares version, VTSAX, has a 0.04% cost, but also a $10,000 minimum investment.

However, those are retail prices. Vanguard also has three tiers of institutional pricing. For a $5 million minimum investment in the Vanguard Total Stock Market mutual fund, the institutional cost is 0.035%.  For Institutional Plus, which requires a $100 million minimum investment, the cost is 0.02%, while that expense ratio drops to 0.01% for Institutional Select, which requires a $5 billion minimum investment.

Those fees show the difference between the products, says Sarah Parker, senior managing director at Hartland, who works as an investment consultant to plan sponsors and is on the investment committee for PSCA.

“It’s two different investors,” she said. “It’s the retail versus the institutional. And the institutional world has institutional pricing.”

Tom Conlon, head of client relations at Betterment for Business—Betterment’s 401(k) business line that uses ETFs for its clients—agrees it’s hard to touch Vanguard’s pricing at the large institutional level. But for smaller plans like the ones they service—plans with 50 to 1,500 participants—they’re more likely to incur higher costs with a traditional 401(k) that uses mutual funds.

More Problems To Consider
Kweku Obed, managing director at Marquette Associates and vice chair of PSCA’s investment committee, says that aside from smaller plans not having the economies of scale to take advantage of cheaper mutual funds, they typically won’t have an institutional investment consultant working with them to devise the qualified plan.

“An institutional investment consultant will typically not push for ETFs,” Obed said, “whereas financial advisors will typically advise some of the smaller plans, and I think advisors like ETFs a lot more for it.”

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