Has the Time Come for ETFs in DC Plans?

Neil Plein, vice president, Invest n Retire, LLC, told PLANSPONSOR there is a lot of pushback for using ETFs in DC plans from people who say there is no need to use them rather than index mutual funds. These people say the costs are the same.  

Invest n Retire told plan fiduciaries it has seen that index funds do not compete with ETFs, but there was previously no study to compare costs. Therefore, Invest n Retire set out to substantiate claims that the costs are the same.  

Invest n Retire has approximately 25 investment managers across the U.S. that have analyzed retirement plans to prepare proposals, so there are thousands of these plan analyses in its system. Ninety-two plans from all over the country were chosen at random, and with their permission, Invest n Retire analyzed the cost of their investments using data from Form 5500s and plan audit reports.  

According to a report Plein wrote about the study, the expected decrease in pricing was observed as a function of plan size. For the micro plan market (less than $5 million in assets, the largest pool of plans studied), the average cost of an index mutual fund was 52 basis points (0.52%). For the small plan market ($5 million to $50 million), the average cost was 36 basis points, for the mid-size plan market ($50 million to $200 million), the average cost was 24 basis points, and for the large market (more than $200 million), the cost was 12 basis points.  

By taking the five major indexed asset classes from the study and the respective ETFs for each class from the three major service providers, an average cost of 18 basis points (0.18%) can be established. Given that ETFs do not have multiple share classes or minimum asset levels for investment, the expense ratio of ETFs for retirement plans would be the same regardless of plan size. At this rate, index mutual funds only become truly competitive in the large plan market ($200+ million in assets).  

So, why are ETFs more cost effective? Plein explains that the main two reasons are: 1) ETFs are traded in the open market throughout the day like a stock, whereas a mutual fund must be traded through an investment company; there are higher costs associated with exchanging a fund via a company as compared to exchanging a fund through an exchange; and 2) ETFs have a lower turnover ratio than mutual funds; the way ETFs are constructed, participants are only paying the cost of the day, whereas mutual fund investors have to pay trading costs with each turnover of fund.  

“ETFs are really maximizing the cost effectiveness in every aspect of their design,” Plein adds.  

He concludes that while plan sponsors are in the position of closely looking at expenses and making sure investment costs are reasonable, they should take a serious look at using ETFs.  

“We are really big proponents of helping the average participant, and ETFs are a good way to do that,” Plein says. “They [ETFs] are waiting for their breakout in retirement plans, and we’re hoping with fee disclosure, now will be the time sponsors will look at ETFs as a way to lower costs and increase outcomes for participants.”