From the January 2008 issue of Research Magazine • Subscribe!

Target-Date ETFs: Ahead of Their Time?

Traditional mutual funds still rule the $2.5 trillion 401(k) marketplace, but that could soon change. Target-date ETFs have crashed the party.

In October, XShares Advisors launched five target ETFs that follow Zacks Lifecycle indices. The funds have laddered retirement target dates that range from 2010 to 2040 and charge annual expenses of 0.65 percent, lower than the layered expenses that mutual funds with a similar strategy charge (0.73 percent, and that's not counting the cost of owning the underlying funds).

The main idea behind target-date funds is to simplify the process of asset allocation because the mix of stocks and bonds automatically adjusts as the target retirement date is reached. As the projected retirement date approaches, the allocation to stocks is generally reduced while the allocation to bonds is increased.

Target-date funds have become such a hit with fund investors saving for retirement that according to Lipper, there are now 205 such funds with roughly $160 billion in assets -- about 91 percent of it in retirement accounts. Over the past five years, asset growth has been growing at a stellar pace of 65 percent.

Could target-date ETFs enjoy this sort of success? As promising as the prospect looks, some industry observers have their doubts.

"Target-date ETFs will not be able to compete in the 401(k) market because of the same problems facing all ETFs," argues Darwin Abrahamson, CEO of Portland, Ore.-based Invest n Retire, which has developed a proprietary system to help 401(k) sponsors process ETFs. "Retirement plan providers do not have the technology to trade and record-keep ETFs like us."

In this, target-date ETFs face the same uphill battle as all ETFs: technology. Unless ETFs are offered through a next-generation retirement platform that sidesteps or minimizes trading costs, the benefits they offer the retail investor are greatly diminished.

"If a 401(k) participant wants to invest in a target-dated ETF, the participant will have to open a brokerage account," Abrahamson says. "Plan sponsors that want target-dated funds are going to offer open-end funds that do not require a brokerage account."

If ETF providers can align themselves with retirement platforms that eliminate or reduce the transaction costs of obtaining their funds, a 401(k) shake-up could be on the horizon. For now, the benefits of target-date ETFs may be limited to individual investors who have a self-directed retirement plan or IRA.

---

Ron DeLegge is the San Diego-based editor of www.etfguide.com.

Reprints Discuss this story
This is where the comments go.