ETF giant State Street says 401(k) plan to face new low-cost challenge
A recent decision by the Securities and Exchange Commission to begin allowing fund companies to create ETF share classes from traditional mutual funds is expected to lead to a flood of new ETFs in the market, but State Street‘s fund management arm, State Street Investment Management, has other ideas.
The ETF giant manages approximately $1.7 trillion in the SPDR family of ETFs, including the oldest and most-traded S&P 500 exchange-traded fund. SPYand the largest gold ETF, GLD — sees the SEC green light as an opportunity to bring a new ETF challenge to the retirement plan market.
In reversal of the SEC decision, it plans to offer mutual fund share classes of ETF strategies in the massive U.S. retirement plan market, which is generally closed to ETFs.
Anna Paglia, chief business officer of State Street Investment Management, said on CNBC’s “ETF Edge” Monday that retirement plan markets, including the 401(k) and 403(b) market, where ETFs have not been represented as core index fund options until now, represent an opportunity she estimates at $4 trillion and will be the focus.
Some of the benefits of ETFs, such as more tax-efficient trading, may not be important to investors in tax-deferred retirement plans. Intraday valuation of ETFs (they trade in real time throughout the day, like stocks, as opposed to once-daily valuation of traditional mutual funds) has also been an issue for some plan sponsors. But State Street’s low fees and massive scale of assets under management give it an advantage in providing competitive portfolio offerings to investors and retirement plan sponsors.
“We now have $1.7 trillion in ETF assets,” Paglia said, explaining that the company could use its existing scale to create a more competitive offering regardless of share class. “The enemy of productivity is fragmentation,” Paglia said.
Inside a Barron’s column The tax efficiency that attracts many investors to ETFs cannot be replicated in the retirement plan market, but so-called “in-kind flows” used in ETF management can lead to lower costs and better performance for retirement investors over time, Paglia wrote in a recent article to explain the company’s thinking.
“This is because when large institutions purchase ETF shares, ETFs do not have to sell investments to raise cash like mutual funds. Instead, ETF issuers can transfer securities directly to these large institutions, typically market makers or broker-dealers, through ‘in-kind’ payments. By avoiding selling in the open market, this process helps reduce turnover and associated trading costs in the underlying portfolio – efficiencies that benefit investors across all share classes,” Paglia said.
State Street’s top ETFs
- SPDR S&P 500 ETF Trust (SPY)
Assets: $698 billion
Expense ratio: 0.0945% - SPDR Gold Shares (GLD)
Assets: $132 billion
Expense ratio: 0.40% - State Street SPDR Portfolio S&P 500 ETF (SPYM)
Assets: $95 billion
Expense ratio: 0.02% - Technology Select Sector SPDR Fund (XLK)
Assets: $95 billion
Expense ratio: 0.08% - Financial Select Sector SPDR Fund (XLF)
Assets: $52 billion
Expense ratio: 0.08%
Source: State Street
The SEC recently began greenlighting ETF share classes of traditional mutual funds. Dimensional Fund Advisors. The mutual fund industry is expected to move in droves to adopt this new ETF provision. More than 70 fund providers have pending applications, and ICI, the main fund industry trade group, recently told “ETF Edge” that it is working with hundreds of fund companies to prepare to take advantage of the SEC exemption.
But the current government shutdown has postponed all other actions, including State Street’s plans to introduce ETFs as mutual funds in the retirement market. Once State Street Investment Management is able to move forward, the question will arise as to which ETFs in particular might stand out in the 401(k) market. While greater trading and cost efficiencies can be achieved by trading in multiple share classes, many of the basic strategies across the ETF lineup are: Already offered by State Street to retirement investors in traditional fund portfolio shares.
And in an asset management industry owned by ETFs and index funds from giants like Fidelity Investments and Vanguard Group literally reduced wages to zeroEconomies of scale between portfolios are already critical in competing for investor assets. Fidelity currently offers four zero-fee core index mutual funds. The expense ratio on Vanguard’s record-breaking S&P 500 ETF (VOO), which sets an all-time high in annual flows for an ETF, is three basis points (0.03%). State Street SPYM, a new version of SPY, has an expense ratio of two basis points (0.02%).
But ETFs have become the go-to way for many investors to access all kinds of market strategies, from core equity to thematic equity and increasingly narrow slices of the bond market, as well as alternatives such as precious metals and cryptocurrency.
“Mutual funds are the way ETF-focused companies meet investors where they are,” VettaFi head of research Todd Rosenbluth said on “ETF Edge.”
He noted that State Street is not the only asset manager planning to create mutual fund share classes of ETFs, with F/M Investments planning a similar approach to benefit from the SEC decision.
Making the world’s largest gold fund more widely available through 401(k) plans, potentially at a lower cost, comes at a time when many more investors are adding gold as a larger allocation to a traditional portfolio, often at the expense of bond funds. But given the low-cost stock and bond options available among major fund companies and retirement plan providers, Rosenbluth said State Street’s biggest opportunities to stand out at the individual portfolio level beyond GLD in the 401(k) market may be Select Sector SPDRs like XLK and Portfolio strategies are generally only available to institutional investors.
ALLW, a global multi-asset allocation fund, includes billionaire hedge fund manager Ray Dalio’s Bridgewater Associates as sub-adviser. PRIV was the first ETF with significant private credit exposure to be approved by the SEC, but it was not without some controversy.
Paglia explained that the plans are less about marketing a specific strategy and more about creating a structure for State Street’s fund business that could bring the best of the ETF structure to more markets. “ETF technology is the most efficient technology in this market, but ETF technology is not a one-size-fits-all package,” Paglia said on CNBC’s “ETF Edge.”
“In my view, the pension industry is not benefiting from the innovations that the ETF industry is bringing to the market and benefiting from,” he added.
To be sure, State Street is already a huge player in the retirement market, ranking third in assets under management in “defined contribution investment only” assets (those pooled through other third-party managed retirement platforms). State Street does not have its own defined contribution recordkeeping like those offered by Fidelity, Vanguard, and Empower. However, for assets covered by strategies in retirement plans, State Street only accounts for Vanguard and Black Rock (which operates the iShares family of ETFs) is worth over $800 billion, with annual growth of 19% through 2024, according to Cerulli Associates.
According to Cerulli, State Street has historically had more collective investment trust offerings for the retirement market than traditional mutual funds, and depending on the ETF strategies they tailor to mutual funds, there is opportunity for growth in the small- and mid-cap market plan segments that have historically had limited access to CITs due to their size.
The fragmentation Paglia mentions stems from the fact that there are many legal wrappers for portfolio strategies used in retirement plans, including collective investment funds, target date funds, mutual funds and ETFs.
“My IRA invests in ETFs, but my 401(k) plan does not,” he said. “This is not a debate between ETFs and mutual funds,” Paglia said. But he added that State Street could benefit from the size and scale of its ETF business as the SEC allows asset managers to own different classes of shares when the government reopens. “We have the power to scale,” he said. “We also have the power of content, because we have hundreds of strategies. … and when you combine content and cost, you get something that investors can ultimately benefit from.”
Correction: A previous version of this article included incorrect holdings under management data for the top State Street SPDR ETFs.
