Why aren’t DC plans including ETFs in their rosters?
Despite their growing popularity within DB pension plans, exchange-traded funds (ETFs) are relative wallflowers in the DC world. These funds—which track an index but are actually traded on stock exchanges and experience intraday price changes—are practically non-existent on Canadian DC plan investment lineups.
“I don’t think that’s something that’s going to change in the next little while,” says Kin Chin, director, DC solutions, with BlackRock Canada.
Mark Yamada, president and CEO of PUR Investing, agrees. “There’s been no growth and little movement.”
What’s Missing?
Recent research from ETFGI finds the ETF and exchange-traded product industry in Canada had US$62 billion in assets at the end of January 2015, the most recent data available.
But Canadian DC plans haven’t contributed to these numbers because the infrastructure isn’t there to support ETFs, money managers say. “[Insurers in Canada] have old recordkeeping systems that can’t handle assets that are valued more than once a day,” says Yamada, who adds upgrading these systems would be expensive.
Geneviève Drolet, investment strategies consultant with Desjardins Insurance, acknowledges the operational issue. “It’s more cost-efficient to invest in a pooled fund that replicates an index than to buy an ETF,” she says. “It’s cheaper and better for the participants and the plan sponsors.”
PUR Investing has had a few active DC plan members looking for help to lobby plan sponsors to offer an ETF option. But Yamada says it’s a very small percentage. “Certainly, as a plan sponsor, if your recordkeeper can’t handle it, that’s all you have to hear. There’s no motivation to really push it forward.”
And technical infrastructure is only one issue. “There’s less money in ETFs for the recordkeeper,” says Gerry Wahl, managing director of The Pension Advisor, a pension consulting firm. They make things easier for committees and plan members with simplified education, he explains. They’re also less onerous for sponsors in terms of fiduciary risk of selecting funds—and perhaps there’s less reliance on the use of advisors.
Like most DC plan sponsors, Western University doesn’t offer stand-alone ETFs, though some of its asset managers may invest in ETFs as part of their strategy. While some of the university’s plan members have inquired after ETFs, Martin Bélanger, director of investments, says the main issue is cost. “We can access the same strategies at a lower cost directly by investing through various institutional investment managers.” The plan has four in-house strategies that can use ETFs but chooses to invest instead in a third-party index fund. “For the FTSE TMX Universe Bond Index ETF, the total management expense ratio [MER] is 33 basis points; our manager charges us six basis points to manage the exact same portfolio that replicates that exact index,” he says. “The vehicle itself is not the difference. There’s no difference between investing in the ETF that replicates the overall bond index as opposed to investing in our funds.”
Thomas Caldwell, CEO of Caldwell Securities, has concerns about index funds. For instance, he points to an ETF based on the TSX. “Instantly, you’re heavily skewing the portfolio to energy, metals and financial services,” he explains. “It may be a good place to be, but it hasn’t been a good place to be for the last little while.”
ETFs also have an unnatural influence on markets, he adds. “In the old days, the stock price was influenced by technical or fundamental factors—the company, the economy, the industry,” he explains. “Now a stock will move on its weighting change within an index.”
Another issue is plan member engagement and education. Caldwell says ETFs can work for DC plans when members want control over investment decisions. “[An ETF] does have the benefit of keeping people out of some highly speculative securities. So it helps to protect people against themselves, to some degree.”
However, that assumes engaged DC members, and Yamada isn’t convinced there are a lot of those. “Investors generally don’t want to be educated. Money spent on consumer education has a very low payback, particularly in pension plans,” he says. “How do you get somebody who is 25 or 30 years old to focus on an event that’s 35 years in the future? It won’t happen.”
Jason McIntyre, head of distribution for Vanguard Investments Canada, adds, “If somebody wanted participants to have access to intraday trading, that’s one of the benefits of ETFs, [but] we don’t see a lot of demand for that on the plan sponsor side.”
Lack of interest in investing among plan members is also evident in call centre requests, notes Wahl. He says most members are asking for account balances or requesting name or address changes. That observation is corroborated by Benefits Canada’s 2014 CAP Member Survey, in which only 35% of plan members reviewed all of their plan statements—a drop from 72% in 2008.
Role to Play
Despite these complexities, ETFs do give pension plans exposure to a broader universe of investments. “For example, ETFs would allow investors to gain focused exposures to international equities,” explains Greg Walker, managing director, head of iShares institutional business, with BlackRock Canada. Although many members would have access to international equities through EAFE, they may “have the view that Europe will be an outperforming region and Japan an underperforming region, for example. Instead of holding both European and Japanese equities through a broad international equities portfolio, they could have the option to buy a European equities ETF and forgo the Japanese exposure.”
Walker adds, “Most DC plans are not operationally able to provide their plan members with direct access to ETFs—this is a legacy technology issue. However, given the appetite, we are seeing momentum toward DC plans modernizing their systems to allow for this option, but they are not quite there yet.” They do, though, provide access to ETFs via active managers that use the investments.
From a fiduciary perspective, ETFs can be a good choice. “Your fiduciary responsibilities are far less. You have minimized risk when you’re in passive,” says Wahl. “[A plan sponsor] can say, ‘We didn’t give members any more risk than the market.’” He says pension plans can use ETFs as a hedging tool or for short-term risk management, but that’s not what he would suggest for a DC plan. “I would recommend basically a breadand-butter, very straightforward, vanilla-type ETF that follows an index,” he says. “No leverage; nothing fancy.”
So will ETFs ever be part of the DC landscape? Yamada does see an eventual shift. He believes when ETFs hit a tipping point—about 15% to 18% of mutual fund assets in the U.S.—DC pension plans will be forced to accommodate them, and DC recordkeepers will change their systems. “I think we’re a couple of years [away from] it.”
He points to Charles Schwab, which last year introduced an all-ETF 401(k) in the U.S.
Others don’t see the shift happening that soon. “If you have an index fund and ETF, which both do the same thing and are offered at the same MER, why would you use an ETF when there could be added costs associated with the operational aspect of getting it added to a DC platform?” asks MacIntyre. “One of the reasons ETFs are not widely offered on these platforms is because there are index fund equivalents that are offered at similar cost. It’s difficult to make a pound-the-table case that ETFs should be in every single tool kit for plan members.”
Brooke Smith is managing editor of Benefits Canada.