ETFs at Record High, But Not with 401ks

401k, Trump, ETFs
What will it take to increase ETF flows to 401ks?

While part of it has to be attributed to the “Trump Bump,” in market performance, growth of exchange traded funds assets in the first quarter was nonetheless “massive,” according to Cerulli Associates, as assets increased 10 percent to nearly $2.8 trillion. Furthermore, flows into ETFs were $133 billion for the period.

Mutual funds ended the quarter with nearly $13.2 trillion in assets, up 5.1 percent from the end of 2016. Positive flows of $84.2 billion have contributed to growth (0.7 percent organic growth), but capital market performance “has been the main propellant,” according to the research firm.

Despite the explosive growth seen in exchange traded funds, they still struggle for widespread adoption in most 401ks, due mainly to the fact that many of the benefits of the products don’t necessarily translate to the long-term savings objectives of plan participants (low cost being the exception).

Brad Kuhlin, co-founder and chief software architect for Vertical Management Systems, points to technology issues with record keepers as another cause.

“With respect to the lack of ETFs in retirement plans, technology is holding us back,” according to Kuhlin. “The old technology being used by the majority of recordkeeping systems effectively locks them into offering only NAV-based investments, typically mutual funds or Common Trust Funds.”

Legacy recordkeeping systems require that within a given investment CUSIP, all buys and sells for the day must be executed after hours, at the exact same price, across all participants transacting in that CUSIP, he adds.

There are exceptions to the rule on some systems when it comes to trading and pricing company stock. In these cases, however, the solution is so “shoe-horned” into the record keeper’s manual processes, there’s no way the process would scale effectively if all the investments on the system were managed the same way, he argues.

He notes that two design flaws in legacy recordkeeping systems have sealed their fate, preventing them from trading non-mutual fund securities while the markets are open.

  1. A fundamental lack of awareness of cash

“Today’s recordkeeping systems were not designed to be custodial accounting systems. They were created as ‘balance forward’ systems to simply keep a record of how much of a given investment a participant owned, after another system actually made the purchases or redemptions. As a result, the concept of cash as either a legitimate form of property or a medium of exchange was never planned on, and is prohibitively complex to engineer into these systems 30+ years after the fact.”

  1. Absence of proper securities processing

“In general, any type of transaction involves exchanging one form of property for another.  When transacting in financial securities in particular, we exchange cash for shares when buying, and shares for cash when selling. When an accounting system has no awareness of cash at its core, as discussed above, it makes it very difficult―or dare we say impossible―to participate in electronic marketplaces with counter-parties when buying and selling securities. This lack of standard securities processing makes it impossible to buy non-unitized exchange traded funds using today’s recordkeeping systems.”

John Sullivan
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With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.

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