Wisdom Tree Pushing ETFs As a 401(k) Alternative

The exchange-traded fund has gone from being a little-known trading novelty to a respectable investment tool, with over $400 billion in assets under management in the United States. But even as ETFs have worked their way into many portfolios, they have been left out in the cold from one of the biggest markets of all: 401(k)s. With more than $2.4 trillion in mutual fund investments tied to the 401(k) market, that is a significant market to be excluded from.

In some ways, ETFs are a great fit for 401(k)s: they tend to have lower fees than mutual funds (including index funds), while offering far greater transparency, which makes them perfect for asset allocation strategies.

However, there are significant barriers to entry. For instance, one of the chief benefits of an ETF—that it trades like a stock—is also a matter of concern for plan sponsors. Transaction costs—either from weekly automatic contributions or from active trading—have the potential to outweigh any savings from the lower expense ratios. Also, record-keeping issues arise from the fact that ETFs trade intraday like stocks, rather than having an end-of-day NAV like mutual funds. And, of course, there is always the risk of trying something new: a significant obstacle in the conservative world of retirement investments.

“ETFs don’t exactly fit cleanly into the current framework,” says Wisdom Tree President and COO Bruce Lavine.

Still, folks like Lavine are getting interested. Recently, WisdomTree Investments (WSDT.PK) formed a new business unit to promote its ETFs as 401(k) offerings, hiring Al Shemtob as director of retirement services. Shemtob was previously president of Bisys Retirement Services, where he worked (along with a predecessor firm) for 17 years.

Wisdom Tree’s fundamentally weighted ETFs are perfect tools for retirement investors, Lavine says.

For Lavine, the challenge is a matter of finding a way to deal with the problems around clearance, settlement, and trading. He’s not too worried about whether there will be demand for the products. Lavine points out that ETFs are already extremely popular with retirement investors in self-directed IRAs, so there is a market for them.

WisdomTree, Invest N’ Retire Go Separate Ways
The flip side to WisdomTree’s announcement is a break with the leader in the 401(k) ETF industry: Invest N’ Retire. Invest N’ Retire uses proprietary, patented software to get around many of the biggest issues impacting 401(k) ETFs, including bundling trades so that transaction costs are spread across multiple users and finding ways to address the issue of record keeping.

The Invest N’ Retire platform features ETFs from multiple providers, including iShares from Barclays Global Investors [BGI] and the full suite of PowerShares products. In January, it was announced that Wisdom Tree’s ETFs would be included on the platform, but the deal was later abandoned.

Invest N Retire founder Darwin Abrahamson would not comment on the failed deal other than to say his firm does not currently work with WisdomTree.

Abrahamson did say that he believes ETF providers looking to get their ETFs into 401(k) plans face an uphill battle, mainly because of the technology issues prevent most 401(k) providers from adding ETFs to their platforms. He says he only adds ETFs to his firm’s platform if they meet certain criteria, and if there is demand. Invest N Retire will not sell the proprietary technology that allows it to do this, but Abrahamson believes that it is only a matter of time before firms like Vanguard and Fidelity accept that ETFs are the next step in 401(k)s and invest in their own technology.

Abrahamson says his firm has seen dramatically increased interest in ETFs for 401(k)s over the last six months, with plan sponsors driving the demand. The successful spread of ETFs is part of the reason, but the recent implementation of new rules from the Department of Labor requiring mutual fund companies and retirement plan service providers to fully disclose revenue sharing activities are another factor. Abrahamson believes that once people saw how much more they were being charged in fees than they had previously assumed, they began to look to ETFs as a new alternative.

Lavine also believes that ETFs have an important role to play in 401(k) investments, and is optimistic that the immediate obstacles can be addressed. He says that WisdomTree had the option of creating a unique set of mutual funds for the 401(k) market, but decided against it, believing mutual funds to be “yesterday’s technology.” Instead, WisdomTree will promote its existing ETFs as components for a 401(k) plan.