The movement to leverage the low cost and tax efficiency of exchange-traded funds (ETF) into the 401(k) arena has taken wing.
Last week, the Maryland-based investment management firm Banneker Capital became the fourth firm to launch a 401(k) ETF program, when it rolled out its "ETF Advantage" platform, offering customized asset allocation portfolios to plan sponsors and participants. Other firms offering ETF-based retirement programs include Invest N' Retire, Amerivest (from Ameritrade) and Park Avenue Securities, a division of the Guardian Life Insurance Company.
Little over a year ago, the idea of using ETFs in 401(k) portfolios was nothing more than a pipe dream, as the commission costs associated with buying the funds was thought to drown out any associated savings. But breakthroughs in the ways that plan providers can consolidate trades from different accounts have helped a few industry pioneers overcome this hurdle, and all signs suggest that more offerings are on the way. (For more on the development of these funds, see Matt Hougan's recent article on IndexUniverse.com.)
Using Passive Funds in Active Ways
Interestingly, many of these programs are using the passively managed ETFs to create actively managed accounts. This passive-active strategy may be one of the first developments in the "active indexing" arena, a field some have called the next frontier in the indexing industry.
Both the Invest N' Retire and the new Banneker platform use ETFs to create dynamic "asset allocation" models, which are individualized to the specific needs of plan participants. The active management component, in both cases, comes in the how the mix of ETFs is selected, and in how (and how often) it is rebalanced.
"What we do with this product is utilize a core and satellite approach," said Rob Goldman, Chief Investment Officer for Banneker Capital. "For example, in a growth portfolio, we would invest in core ETFs - like SPDRs and the iShares fixed-income funds - and then in the satellite portion of the portfolio, we would invest in sector ETFs. When the portoflios are rebalanced, the sectors are rotated using our proprietary investment process, the Banneker Quad-Score. And that's where we believe a great deal of value can be added."
The Bannerk Quad-Score is a scoring and ranking system for industry sectors and stocks within those sectors. According to models available on Banneker's Web site, the portion of a portfolio that is actively managed in sector ETFs decreases as the time horizon shortens or risk tolerance shrinks.
Banneker's core-and-satellite approach brings to mind one of Steven Schoenfeld's predictions in his article "The Future of Indexing," which was named "Best Indexing Article" at the recently held 2004 IMN/IndexUniverse.com Innovations in Indexing ("5 I's") Awards ceremony.
"The first 'pure active' ETFs," Schoenfeld wrote, "will likely have some element that is index-based: either a 'core' index component from which the creation/redemption mechanism takes place, or through a sector rotation or multi-asset class rotation approach, where index-based subcomponents are actively managed."
Although Schoenfeld was writing about an individual ETF, his comments apply: Banneker's managed portfolios can almost be seen as an individualized fund of funds for the ETF world.
Of course, active management in 401(k) portfolios has been around for a long time. The difference with ETFs is that this management service can be provided at a low cost.
Goldman said, "While we don't publish our fees for competitive reasons, the ETF Advantage 401(k) is one of the low-cost solutions availabe in the market today. Period."
The Banneker platform - which can be used as either a stand-alone 401(k) program or as part of a broader platform - allows participants to choose between a "Lifecycle" and a "Lifestyle" planning program. In the Lifecycle program, participants simply enter their current age and their planned retirement age, and a portfolio mix is generated to match their needs. In the Lifestyle program, risk tolerance and other financial goals are taken into account.
"One of the things that is so elegant about this product is that it's not just low cost. As a managed product, it can give fiduciary serenity to the plan sponsor, while it gives the plan participant the peace of mind of knowing that their retirement nest egg is professionally managed," Goldman added.