Related topics: ETF, investments, Charles Schwab Bank, mutual funds, 401k
Jim McCool, executive vice president of institutional business at Charles Schwab (SCHW, news), made waves at a recent asset-management conference when he announced that the brokerage company soon would offer 401k retirement plans stuffed solely with exchange-traded mutual funds -- and let investors trade them without charge.
"You could tell the rest of the room was nervous about it," says Mike Alfred, co-founder and chief executive of BrightScope, an independent rater of 401k plans, who heard the comments. "The idea is disruptive."
ETFs, which typically carry low fees and trade like stocks on exchanges, have exploded in popularity, a rare source of growth in the otherwise stagnant mutual-fund industry. ETFs now hold $997 billion in assets, up from $65.6 billion a decade ago. Still, ETFs have yet to make a dent in employer-sponsored 401k accounts, a $2.8 trillion market.
Schwab, just a bit player in 401k's now, sees ETFs as a way to edge closer to giants such as Fidelity Investments, Aon Hewitt and the Vanguard Group. According to consulting company Cerulli Associates, those three had a combined market share of about 43% in 2009, the latest year for which data are available.
Schwab doesn't disclose publicly how much of its $4.2 billion in annual revenue comes from the 401k business. Cerulli ranks the San Francisco company 10th by assets, at $72.5 billion.
Many 401k's, particularly those offered by Vanguard, already offer a thick menu of low-cost index mutual funds. So Schwab's main targets are companies where 401k plans consist largely of actively managed mutual funds. Such funds charge higher fees than index funds or ETFs.
Adding ETFs to 401k plans could put more pressure on actively managed fees, a trend that began with the introduction of index funds in the 1970s.
"Moving to an ETF-based 401k program is something new and certainly could have profound impacts for the asset-management industry," says Alex Kramm, an analyst with UBS Securities.
ETF critics say the offerings can be more volatile than regular mutual funds, as seen in last year's May 6 "flash crash," when some ETFs briefly plummeted to near zero, only to roar back moments later. And because ETFs can be bought and sold at any time in the trading day, rather than just once a day like regular mutual funds, ETFs tend to encourage rapid-fire trading, critics say.
The volatility and heavy trading have caused some ETFs to stray from their benchmark indexes. For example, in the days after the March earthquakes in Japan, three U.S.-sold ETFs that broadly track the Japanese stock market all recorded losses even as the indexes they mirror rose.
Skeptics warn that active trading of ETFs in 401k's could subject investors to unnecessary volatility. "There will be a lot of resistance," Kramm says.
By opening ETFs to so many investors, critics say, Schwab's plan could leave the market more vulnerable to these forces. It also could eat into Schwab's core retail-brokerage arm, which holds the bulk of the company's $1.65 trillion in client assets.
