June 1, 2011

Schwab Bets Big on 401(k)s Packed With ETFs

'Schwab is betting it all,’ says BrightScope’s Alfred

Jim McCool, Charles Schwab's executive vice president of institutional business, made waves at an asset-management conference in March when he announced that the brokerage firm soon would offer 401(k) retirement plans stuffed solely with exchange-traded funds. The Wall Street Journal reports he added that the San Francisco-based investment giant would let investors trade them without charge.

"You could tell the rest of the room was nervous about it," Mike Alfred, co-founder and chief executive of BrightScope Inc., told the paper. "The idea is disruptive."

The Journalnotes Schwab is a bit player in 401(k)s, but sees ETFs as a way to edge closer to giants such as Fidelity Investments, Aon Corp.'s Aon Hewitt and Vanguard Group. According to consulting firm 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 401(k) business. Cerulli ranks the Schwab 10th by assets, at $72.5 billion.

Adding ETFs to 401(k) plans could put more pressure on actively managed fees, a trend that began with the introduction of index funds in the 1970s, the paper says.

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.

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 firm's $1.65 trillion in client assets.

"Schwab is betting it all," Alfred added. "They could cannibalize their own business. Compared to other players, they're a chipmunk among gorillas. The question is whether they're going to be a chipmunk that is growing."

"For a long time, people haven't been able to figure out the ETF and 401(k) mix," Schwab CEO Walter Bettinger told the paper. "I think we're the one company who is entrenched in the industry today who has a motivation to do so."

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