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Portfolio > Mutual Funds

Say Hello to a New Low-Cost Index Fund; Latest Thinking on Active vs. Passive

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Investing in the 1,000 largest U.S. companies became cheaper and the competition between low-cost index providers got stiffer when Charles Schwab rolled out its index ETF comprising the 1,000 largest U.S. stocks on Oct. 11.

The Schwab 1000 Index ETF (SCHK) has an operating expense ratio of five basis points (0.05%) and is available on Schwab ETF OneSource, the firm’s commission-free ETF platform. The firm says rival products have charges of between 10 and 15 basis points.

The new ETF will be the 22nd fund in Schwab’s ETF lineup. Schwab introduced its first ETF in 2009 and currently has $88 billion in ETF assets. It is the fifth-largest ETF provider after BlackRock (iShares), Vanguard, State Street (SPDR) and Invesco (PowerShares).

“We launched the Schwab 1000 Index and mutual fund in 1991 to help investors participate in the innovation and long-term growth of the largest 1,000 stocks in the U.S. in a simple and cost-effective way,” said Charles Schwab, the company’s founder and chairman, in a statement. “I’m thrilled that investors can now benefit from the potential growth of these firms with the ease and efficiency of a low-cost ETF.”

Marie Chandoha, president and CEO of Charles Schwab Investment Management, said the new ETF provides “one more affordable way” for Schwab’s “wide range of investors with different needs” to access the U.S. stock market.

In Defense of Index Investing

As the popularity of index investing has surged, so has commentary citing concern about its growth. These concerns are often presented under attention-grabbing headlines.

In its October ViewPoint, BlackRock — which manages the iShares ETFs — considers some of the questions being raised. The concerns have two themes, it says.

Some commentators have asked whether index funds — index mutual funds and exchange-traded funds — have the potential to distort investment flows, create stock price bubbles or, conversely, aggravate a decline in market prices.

Others have focused on index investing, stock ownership and competition and ascribed higher consumer prices, escalating executive compensation and aspects of wealth inequality to index investment products; academics call this “common ownership,” i.e., ownership by a single entity of shares of multiple companies in an industry.

According to the BlackRock paper, overall asset allocation decisions of asset owners drive investment flows into different asset classes and sectors. Index funds are merely a vehicle for asset owners’ views; the funds themselves do not drive equity market prices or individual stock prices.

Absent index funds, it asserts, these asset allocations decisions would be executed through an alternative means, such as active funds or individual stocks.

Despite what headlines say, active strategies dominate both stock trading and information sources used in price discovery, according to BlackRock. Index investing comprises only some 20% of global equities, with index funds and ETFs representing 7.4% of global equities.

Even though index investing is growing more rapidly than active strategies, BlackRock believes the balance in market share between the two is self-regulating. It says the market share of index investments is not at the point where pricing inefficiencies have opened up; even if it did, active managers would benefit from opportunities to profit from short-term fluctuations in individual stock price.

This could improve active performance and would likely attract asset flows back into active management, which in turn would result in a new equilibrium between the two styles.

The BlackRock paper points out several benefits of index investing:

  • Index funds provide capital to many companies across size, geography and sector;

  • Index investors take a long-term view on companies they hold, providing stability;

  • Large index fund sponsors actively engage in investment stewardship; and

  • Index funds democratize access to diversified investment portfolios.

BlackRock notes that several global trends are driving adoption of index investing strategies. For one, awareness is growing of the value proposition they offer in striving to track rather than better a benchmark index.

For another, investors and regulators are increasingly focused on fees and transparency. Plus, changes to brokerage and advice models have led investment advisors to act less as stock or fund selectors and focus more on building diversified portfolios, often delivered through index funds.

TDFs with ETFs

Stadion Money Management has created a new target date solution that’s designed to mitigate the one-size-fits-all “Achilles heel” of traditional target date funds. With TargetFit, Stadion aims to address this and other limitations of traditional target date strategies while keeping the ease of use and familiar structure.

“We see a move towards giving participants more than just a one-size-fits-all solution, which is the way most target dates are built,” C. Todd Lacey, chief business development officer at Stadion Money Management, told ThinkAdvisor. “So your traditional target date funds, they’ve served a great purpose, but they’ve been somewhat limited in their approach — meaning every person is invested the exact same way based on their age.”

While the number of target date funds has grown significantly in recent years, their overall construction has largely stayed the same. They generally offer one glide path and often invest in only a single fund family.

“Target dates have been around now for maybe 15 years. They have probably close to a trillion dollars in assets in them, and they’re in many cases the single biggest holding in any 401(k) plan. And they’re great when you compare them to people doing it on their own,” Lacey said. “But the next question is ‘Are they good enough?’ And we’re really looking at it as we think we can make them better for participants.”

There are three specific ways that TargetFit is trying to make target date solutions better: multiple glide paths, participant education and exchange traded funds. TargetFit offers three distinct target date fund glide paths.

“What we’ve tried to do with TargetFit is create optionality based on people’s risk profiles,” Lacey explained. “So if you’re more aggressive and I’m more conservative in our investor profile, we have different glide paths that we would be on.”

The three glide paths offered are for a “conservative” investor, or someone who is cautious about their savings and investment choices; a “moderate” investor, or someone who doesn’t mind taking some risks with their savings; and a “growth” investor, or someone who is more aggressive with investing their money and isn’t fearful when their investments fluctuate.

Stadion believes that there are fundamental misunderstandings that investors have about target date strategies. According to Lacey, some participants invest in multiple funds as they attempt to diversify their investments, even though each one has diversification built in.

“People misuse target date funds because — while they seem simple to us in the industry — your average everyday person doesn’t always understand them,” Lacey said.

Most retirement investors need additional education about their retirement investments. That’s why Stadion created the TargetFit web-based experience to include education on how target date funds work, investment risk and investor risk tolerance.

“This is not advice,” Lacey explained. “We’re not telling them what to do. What we’re trying to do is give them a baseline education on investor types and target date funds. So they can easily read through that and get a better sense of what that is.”

The third component that makes TargetFit different from the traditional target date fund: It uses ETFs as the underlying investments. According to Lacey, most target date funds are using mutual funds — often, just one family of mutual funds. “We’re using ETFs from multiple ETF providers,” he said. “It’s kind of an open-architecture ETF approach.”

TargetFit’s portfolios are built with ETFs from multiple providers using a selection methodology managed by Stadion’s portfolio management team. Those ETFs are packaged inside of collective investment trusts.

Unlike fixed-path target date funds, TargetFit target date funds include allocations designed to be responsive to changes in the market. With a built-in “flex” allocation, the portfolios have room to react to different market conditions, according to the firm.


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