In the retirement vehicle space, ETFs wither while mutual funds flourish.
The world’s largest ETF issuer, BlackRock, is closing 10 target-date ETFs for lack of interest. And that’s a shame.
The ETFs have been efficient, low-cost vehicles providing a complete long-term investment solution. Funds like the iShares Target Date 2020 ETF (TZG) delivered thoughtful allocation to broad asset classes like stocks and bonds, as well as diversified exposure within each asset class.
Better yet, these funds were built for the long haul, dynamically adjusting their allocations over time, gradually reducing risk. The “target date” in the name refers to the intended retirement date of the investor.
Target-date funds are the epitome of set-and-forget vehicles—a rarity. The investor can walk away for years and still have a balanced portfolio.
In fact, the utter lack of investor participation is a key value-add for the average Joe or Jane. It protects them from self-inflicted wounds, whether from sloth (failure to rebalance their allocations over time); greed (buying hot stocks at their peak); or fear (selling at their low).
In the end, the failure of target-date ETFs isn’t one of concept, it’s one of delivery vehicle. Target-date mutual funds can boast of a huge and growing asset base—totaling $690 billion and up 27 percent in the past year, according to Ibbotson.
Meanwhile, target-date ETFs are dying in the vine. Why?
The most important point is access.
Many individual retirement accounts (IRAs) and 401(k) retirement plans simply don’t offer or can’t support ETFs of any kind, whether target-date or the plain-old S&P 500 funds. An oft-cited reason for this is because ETF shares are hard to work with in fractions (e.g., 42.387 shares), although Schwab and others have found workarounds.
There are other challenges to adoption of ETFs: The long-term allocation space weakens many of ETFs’ well-trumpeted advantages over mutual funds.
First, while ETFs can be traded like a stock, their tradability is something of a nuisance in the context of regular contributions to IRAs or 401(k)s. For each contribution, the plan administrator must worry about best execution of the ETF shares relative to their fair value (net asset value). In contrast, mutual funds get “executed” at end of day, which means at fair value, period.
Over the long haul, the fair value of the mutual fund reflects trading costs too, since the mutual fund manager has to trade the underlying securities. This “friction” is buried in the mutual fund, but worn on the sleeve of the ETF.
Second, the ETF’s tax efficiency is less relevant here. ETFs avoid most capital gains distributions thanks to their creation/redemption mechanism. In contrast, when a big mutual fund investor sells out, it can produce a cash distribution—labeled as capital gains for tax purposes—for the shareholders that remain in the fund. In a tax-deferred account—such as an IRA or a 401(k)—however, this cash flow has no impact from a tax perspective.
You may or may not agree with these reasons, but either way, target-date ETFs haven’t caught on.
BlackRock’s departure from the space leaves five Deutsche X-trackers target-date ETFs as the sole choice for investors. The asset tally of the Deutsche suite is less than that of the BlackRock lineup that's shutting down—a gloomy omen.
At the time this article was written, the author held no positions in the security mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.