BlackRock Wields ETF Weapon to Expand Share of $2.7 Trillion 401(k) Market

BlackRock Inc. is seeking to grab a larger slice of the $2.7 trillion 401(k) retirement market by using its position as the world’s biggest manager of exchange- traded funds to win over small companies.

BlackRock’s iShares unit is going after retirement plans with $50 million or less that have been largely ignored by big providers such as Fidelity Investments and Vanguard Group Inc. Investors in 401(k) plans have bought more than $2 billion of iShares ETFs since the New York-based company began its push last year, Darek Wojnar, head of iShares strategy and research, said in a telephone interview.

“Because iShares is so big, they’re a bellwether of where things are headed,” said Teresa Epperson, a partner at Mercatus, a Boston-based financial consultant. “I think it’s inevitable.”

Exchange-traded funds have struggled to break into the retirement market as Fidelity, the largest 401(k) provider, Vanguard, the fifth largest, and most other large administrators have shunned them, saying they aren’t appropriate for long-term retirement savers. BlackRock is seeking to appeal to smaller plans, which often pay more for investment products, according to Wojnar.

The funds are baskets of individual securities that are structured as stocks and bought and sold on an exchange. ETF costs are generally less than investments available to smaller plans. BlackRock is the biggest ETF manager, with $509 billion in iShares assets, followed by Boston-based State Street Corp. at $205 billion.

Level Playing Field

“It might level the playing field between the big employers and the small sponsors,” said Lawrence Petrone, director of research at Boston-based Financial Research Corp., which studies the asset-management industry. Plans with $50 million or less in assets represent nearly one-third of all 401(k) assets, according to Boston-based Cerulli Associates.

Raylon Corp., a third-generation family business in Reading, Pennsylvania, which sells furniture and hair-styling products to salons, switched from a mutual-fund plan managed by AXA Equitable to one built around ETFs run by Portland, Oregon- based Invest n Retire, according to Chris Raszkiewicz, Raylon’s director of finance.

Raylon, which has $2.3 million in retirement assets among 90 participants, was able to almost halve its expense rate to 1.18 percent, Raszkiewicz said. “The bigger companies get better pricing, but for someone like us, this was perfect,” he said.

The average expense ratio for ETFs was 0.57 percent of assets in 2009, compared with 0.99 percent for index funds and 1.41 percent for actively managed U.S. stock mutual funds, data from Chicago-based Morningstar Inc. show.

Market Will Grow

“Lower fees could mean the difference between an OK retirement and a very nice retirement over the long term,” said Tom Lydon, president and chief executive officer of Global Trends Investments in Newport Beach, California.

The 401(k) market is estimated to increase 41 percent to $3.7 trillion in assets by the end of 2014, according to Cerulli. Exchange-traded funds now account for between $5 billion and $10 billion of 401(k) assets, according to Petrone at Financial Research. He said BlackRock’s ETFs used in 401(k) plans and other retirement accounts could surpass $100 billion over the next decade. Assets in 401(k) plans may grow to about 20 percent of iShares’ net inflows in five years, or about $10 billion a year, BlackRock’s Wojnar said.

Higher Costs

Fidelity, Vanguard, T. Rowe Price Group and Charles Schwab Corp., which collectively administer more than $1.2 trillion in 401(k) plan assets, said trading costs are higher for ETFs, because investors have to pay broker commissions on every trade. Savers who contribute small amounts from their paychecks in weekly or biweekly increments can get hit hard by those costs, according to Stephen Utkus, director of the Vanguard Center for Retirement Research. Pegi Almond, a T. Rowe Price vice president who works with 401(k) plans for the Baltimore-based firm, said that ETFs aren’t appropriate for 401(k)s for the same reason.

“We have not received much demand from plan sponsors to offer it,” according to Fidelity’s Beth McHugh, a vice president in the Boston-based company’s 401(k) unit.

Fidelity, the largest 401(k) administrator with $706 billion in assets, allows savers to buy ETFs only in plans that permit individual brokerage trading, according to McHugh. Fidelity doesn’t track how many people buy ETFs that way. Schwab does the same thing, according to James McCool, an executive vice president for 401(k)s at the San Francisco-based company.

‘Apples-to-Oranges’

Vanguard, the third-largest seller of ETFs, uses them for taxable accounts only, and sticks with mutual funds for its 401(k)s, according to Utkus, of the Valley Forge, Pennsylvania- based company. ETFs generally aren’t taxed until sold while mutual funds distribute taxable capital gains. Vanguard’s fees are low enough that there’s no cost advantage to its ETFs, he said. The Vanguard Total Stock Market Fund charges 6 basis points for institutional shares. The equivalent Vanguard Total Stock Market ETF costs 7 basis points. A basis point equals 0.01 percentage point.

“Mutual funds don’t have bid-ask spreads, and they don’t have brokerage commissions,” Utkus said. “It’s an apples-to- oranges comparison.”

State Street declined to comment.

Fidelity, Vanguard, T. Rowe and Schwab are 401(k) administrators that also sell investment products for the plans, which may give them an advantage, and fees are often bundled together for both services. BlackRock, which has $276 billion in retirement plan assets, isn’t in the plan administration business.

Small Companies

Smaller companies often retain insurance companies and third-party administrators to run their plans, said T. Rowe Price’s Almond. Insurers handle 53 percent of the country’s 401(k) plans, representing 25 percent of assets, according to Cerulli. Insurance companies with large 401(k) businesses include Great-West Life & Annuity Insurance Co., Prudential Financial Inc. and Principal Financial Group Inc., according to an April 5 ranking of 2009 data by Pensions & Investments magazine.

Exchange-traded fund assets in the U.S. surged 67 percent to $750 billion in the year ended in February, according to data from the Investment Company Institute in Washington, as investors sought low-cost alternatives to active funds, which are composed of individual securities picked by portfolio managers. Mutual funds in the U.S. held $10.97 trillion as of February, according to the ICI.

Bruce Lavine, president and chief operating officer of New York-based WisdomTree Investments Inc., an ETF provider backed by hedge-fund investor Michael Steinhardt, said his company has about $50 million in assets from 401(k) investors from about 25 plans.

‘Blown Away’

“One advantage of ETFs that’s overlooked by the people entrenched in the 401(k) business is that ETFs have blown away the offerings in the index mutual fund space,” said Lavine, whose firm manages about $7.3 billion in ETFs. WisdomTree’s Emerging Markets SmallCap Dividend Fund is available only as an ETF and not through an index mutual fund, according to Lavine. The WisdomTree ETF returned 71 percent in the past year, compared with a 67 percent return for the MSCI Emerging Markets Index, Bloomberg data show.

Larger plans sponsors may start exploring ETFs for their employees to stay competitive, Lavine said.

“A year ago there were questions about whether it would be adopted,” BlackRock’s Wojnar said of ETFs. “The questions today are, how quickly? And how widespread?”

To contact the reporters on this story: Amy Feldman in New York at afeldman16@bloomberg.net. Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net;

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