Defined benefit plan advisers have many types of investments to choose from when discussing investment options with their investment committees. Defined contribution plan advisers are mostly confined to mutual fund options. Is that likely to change in the near future? Probably not. Here's why:
Exchange Traded Funds (ETFs)
Exchange Traded Funds are low cost, passively managed investment options that index something. Because of their low cost, many experts felt that ETFs would make significant headway in replacing mutual funds as the investment option of choice in 401(k) plans. That hasn't happened and doesn't appear likely to any time soon. The major reason is that since ETFs trade throughout the day, just like stocks, there is arbitrage risk associated with offering ETFs in a 401(k) plan. Mutual funds, which are valued once a day based upon their closing Net Asset Value (NAV), don't have any arbitrage risk since their value throughout the trading day is unknown. Custodians charge 401(k) plans offering ETFs significantly more as a result of having to manage the arbitrage risk, wiping out the cost advantage that ETFs have over mutual funds.
Separately Managed Accounts
A separately managed account is essentially a custom mutual fund that an asset manager designs for a retirement plan. Popular in defined benefit plans, which are not subject to participant scrutiny, these types of funds are much less prevalent in defined contribution plans for a number of reasons. First, defined contribution plan participants are accustomed to being able to source information about their investment options from many public, objective sources (e.g. Morningstar). Information on separately managed accounts is not available from any public sources since the investment fund is unique and not available to the public. Second, the investment objective and underlying investments of separately managed accounts can be difficult to understand. Finally, separately managed account options are probably too costly for all but the largest defined contribution plans.
Another type of investment not available to the general public, collective trusts suffer from some of the same issues as separately managed accounts. These unregistered investment vehicles often take the form of hedge funds, but when found in defined contribution plans, typically look like mutual funds. Participants who invest in these funds are unable to access publicly available information and easy comparators. Collective trust funds may also be more expensive then institutional share class mutual funds.
Sponsors of these investment options, motivated by the large amount of assets available in defined contribution plans, will continue to try and address the issues that keep these investments from being more widely used.
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). Mr. Lawton was named as a Top 100 Retirement Plan Adviser by PLANADVISER and a Top 300 Retirement Plan Adviser by 401(k) Wire. Mr. Lawton may be contacted at email@example.com 414.828.4015.
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