After a decade of tremendous growth among both retail and institutional investors, in which assets under management eclipsed the $1 trillion mark, exchange-traded funds have yet to gain a meaningful foothold in 401(k) plans, which are still dominated by traditional mutual funds. However, as an increasing number of 401(k) recordkeepers introduce platforms that offer the option to include ETFs, and as the newer generation of ETFs develops a more seasoned track record, the momentum may soon shift in their favor.
Historically, one of the key arguments against incorporating ETFs into 401(k) plans has been the fact that ETFs generally lose certain competitive advantages over traditional mutual funds in this framework. For example, while many investors associate equity ETFs with better tax efficiency than mutual funds, this is irrelevant in a tax-deferred 401(k) plan. And while many investors are drawn to ETFs for their intraday tradability, most 401(k) plans that offer ETFs consolidate ETF trades, which are priced once a day. Even the cost advantages often touted by ETFs are much narrower when compared to institutional share classes offered by some of the largest traditional index mutual funds that are available in larger 401(k) plans. As a result, even as the demand for ETFs in 401(k) plans grows and recordkeepers make adjustments to platforms to allow for their inclusion, many plan advisors have been hesitant to include them.
In light of these obstacles, future opportunities for ETFs to make headway with 401(k) plans may ultimately have less to do with structural “ETF-specific” advantages over traditional mutual funds and more to do with the underlying exposure provided by specific ETFs. After all, while there is plenty of overlap between the investment strategies employed by traditional mutual funds and those followed by exchange-traded funds, there are also numerous strategies and asset classes followed by ETFs that are not presently available via traditional mutual funds.