With elections just around the corner, I could just see this negative ad.
“There are two ERISA attorneys named Ary Rosenbaum. One invests in exchange traded funds (ETFs) for his personal investing. The other one claims that ETFs will only be a niche player in the 401(k) plan business. Ary Rosenbaum, he thinks ETFs are good for him and not for your 401(k).”
ETFs are slowly getting more traction in the 401(k) business and I don’t think it’s a bad thing. I just don’t think that with the way the 401(k) industry is run that ETFs will ever get major play as a suitable 401(k) plan investment.
I liken the whole ETF vs. mutual fund debate in 401(k) plans as a format war. As you know, a format war is when there is a competition between mutually incompatible proprietary formats that compete for the same market. We saw a format war between Blu-ray and HD DVD for high definition DVD technology, but the most remembered format war is VHS vs. Betamax for video tape dominance.
As most people don’t remember, Betamax was actually the better technology. VHS won the format war because its originator, JVC licensed its technology to competitors which lowered the price for VHS video recorders (VCR) while Sony was the only purveyor of Betamax VCRs. The other major difference was that VHS offered two hour recordings on its tape while Betamax only offered one hour. The lesson of this format war is that many times, the inferior product will win.
The reasons that I believe that ETFs will only be a niche player because the 401(k) plan business is dominated by the mutual fund industry. The 401(k) daily trading platforms in the way it operates, strip many of the benefits of ETFs namely because it won’t let participants buy ETFs throughout the day (unless they have a self directed brokerage account) and since participants pay the bulk of 401(k) fees, it will add substantial fees to what is a financially transparent product. ETFs’ main strength is its low fees and fee transparency, these are drawbacks in an industry where fees are still hidden and mutual fund companies pay revenue sharing fees to third party administration firms that remind me of payola and kickbacks. Let us also not forget that many of the daily 401(k) trading platforms are dominated by mutual fund companies like Fidelity, Schwab, Nationwide, John Hancock, American Funds, and ING, companies who would lose out if ETFs became a more dominant form of 401(k) investment. Do you think these companies have any interest in lowering the fees for ETFs when they allow the trading of their mutual funds for free? I highly doubt it.
Do I think ETFs are a proper form of 401(k) investment? Absolutely. While I think more choice in 401(k) investments is better, the pessimist in me thinks that ETFs will still remain a niche player. Perhaps IShares will start its own daily trading platform for 401(k) plans which might be a game changer. Unless something as seismic as that takes place, I think mutual funds will still dominate this format war. Just remember, the best product doesn’t always win.