ETFs Ready For Prime Time In Retirement Plans?

April 15, 2009

Providers say they've upgraded back-office systems to start allowing more flexible ETF trading and portfolio construction in 401(k) plans.


In late March, Don Amsden switched his company's retirement savings plan to an all-exchange-traded funds platform.

The owner of Lafayette Copier Sales & Service Inc. in Lafayette, Ind., had been using a 401(k) plan only offering mutual funds. But about a month ago, the plan's service provider worked out a system that allows participants to create their own portfolios and freely transact using any iShares ETFs currently on the market.

The more flexible system represents a big change for retirement markets. Up until recently, traditional record-keeping processes and transactional accounting systems for funds in 401(k) plans have been geared to work with mutual funds. That meant back-office processes were built for investment vehicles that trade only once a day—at the end—and deal in full shares.

ETFs, of course, trade throughout the day and can be bought in fractional shares.

"In the past, people in 401(k) plans could only invest indirectly in ETFs, typically through third-party unitized funds or collective trusts. That meant you couldn't actually own shares of a stock or ETF—you had to buy a predetermined portfolio sold through a trust," said Greg Moerchen, a partner at ETF Advisor k LLC, the provider of Lafayette Copier's retirement plan.

An exception has been systems allowing employees access to most anything sold through large brokerage houses. In those so-called "self-directed" plans, participants can buy whatever stocks, mutual funds or ETFs they want. But such plans are few and far between. And they can still impose stiff limits on transactions and tack on rather hefty fee structures that are similar to less-flexible 401(k) plans.

Openings For Change

Amsden says neither is the case with Lafayette Copier's new plan. Not only does it offer significantly lower fees, but the plan lets participants trade daily—although it limits transactions to one a day.

"Ideally, that's not what they're going to be doing," said Amsden. "This is retirement money and we're educating our employees on the value of long-term investing. But it's nice that they can tailor their ETF portfolios to their individual needs."

His company, which has about $500,000 in total assets invested in its 401(k) plan, is one of the first to take advantage of upgraded back-office systems.

Since the end of February, ETF Advisor k's outside custodians and back-office specialists say they've ironed out the kinks to handle ETF shares. The back-office provider, Mid Atlantic Trust Capital, expanded its systems with the help of iShares sponsor Barclays Global Investors. The plan's record-keeper and third-party administrator is FutureBenefits of America LLC.

"In the last 30 days, we've been rolling out a next-generation 401(k) platform for ETFs," said Moerchen, whose Fort Wayne, Ind.-based retirement service provider works with about 500 different companies across the country. "Consultants and advisers have been asking for something like this for years."

The firm began marketing its new ETF platform last week. "We've been inundated with calls from advisers," said Moerchen. "This is absolutely the next big wave in 401(k) plans. And it's just starting to take place in a big way now."

ETF Advisor k's sweet spot is small- to midsize plans. It works with fee-based advisers and consultants hired by plan sponsors to help employees build portfolios and make investment choices. Moerchen says his plan's total cost to participants averages around 1.50% a year.

That's within the range BGI says it's expecting most ETF-based 401(k) plans to wind up charging. Studies estimate that plans at smaller companies using mutual funds are averaging around 2.5–3.5% in total expenses, notes Darek Wojnar, head of iShares' product research and strategy group.



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