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New ETFs Target Retirement Market
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by John Spence
Monday, October 22, 2007provided byMarketWatch

First 'lifecycle' ETFs aimed at long-term investors in retirement plans.

The first target-date exchange-traded funds might just lift the velvet rope that has kept ETFs from the biggest party of all: retirement plans.

ETFs listed on U.S. exchanges have grown to more than $500 billion in assets, but they've been unable to make significant inroads into the retirement-plan market, long seen as a cash cow for traditional mutual funds.

At the end of 2006, retirement plans
assets grew to about $2.7 trillion, according to Investment Company Institute, the main trade group for the mutual fund industry. About 50 million American workers participated in retirement plans
at year-end.

Mutual funds have enjoyed a tremendous boost from the rise of the retirement plans because, along with other products such as annuities, they account for most retirement investment options.

ETFs, meanwhile, face several barriers to entry. ETFs are structured as baskets of securities that trade like individual stocks, and broker commissions are required to buy and sell shares. Many wonder if the ability to trade frequently is relevant for long-term investors in retirement plans.

Some firms are working on platforms that would aggregate ETF trades to reduce trading fees. However, the administration and record-keeping of retirement plans is geared to mutual funds.

Tracking the life cycle

In a bid to crack the retirement plans nut, TD Ameritrade Holding Corp. (AMTD) subsidiary Amerivest Investment Management LLC and XShares Advisors have partnered to create a family of the first "lifecycle" ETFs.

Also known as target-date funds, these offerings have been extremely popular choices in retirement plans when offered as mutual funds. The investment products are designed to provide investors with diversified exposure to bonds, U.S. stocks, foreign companies and other asset classes.

Target-date funds are classified by the year in which the worker plans to retire or reach some other major financial goal. These products are designed to automatically scale back risk as the investor gets closer to the target date, typically by selling stocks and buying income-producing bonds.

So-called balanced funds, which include lifecyle offerings and invest in both stocks and bonds, are increasingly popular with younger workers in retirement plans.

"More recently hired participants hold balanced funds and are more likely to hold a high concentration of their accounts in balanced funds," wrote the ICI in its latest review of the retirement plans market.

"In addition, at year-end 2006, 24% of the account balances of recently hired participants in their twenties is invested in balanced funds, compared with 19% in 2005, and about 7% among that age group in 1998," the group said. "A similar pattern occurs across all age groups."

Apart from target-date funds, the ETF business has been trying to break into the retirement-plan market for years. There are already "funds of funds" and separate accounts that use ETFs for the underlying investments.

Additionally, BenefitStreet Inc. and money manager Barclays Global Investors earlier this year struck a deal to distribute ETFs to corporate sponsors.

BenefitStreet, which handles record-keeping and many client-support functions, last month launched a new retirement plans platform enabling investors to choose both ETFs and mutual funds in the same plan.

WisdomTree Investments Inc. (WSDT) recently unveiled a retirement plans platform designed for retirement plans, while Invest n Retire LLC in Portland, Ore., is a back-office specialists offering ETFs directly to employers.

Long-term horizon

TD Ameritrade and XShares have launched five new target-date ETFs: TDAX Independence 2010 ETF (TDD), TDAX Independence 2020 ETF (TDH), TDAX Independence 2030 ETF (TDN) and TDAX Independence 2040 ETF (TDV) and TDAX In-Target ETF (TDX).

The lifecycle funds get progressively more aggressive the further out the target date. For example, TDAX Independence 2010 ETF has an initial allocation to 8% in international stocks, 25% in U.S. stocks and 67% in fixed-income, although the allocations change over time.

However, the TDAX Independence 2040 ETF has an initial 24% stake in international, 73% in domestic stocks and 3% in bonds. The TDAX In-Target ETF is the most conservative, with 89% earmarked for fixed-income.

Bill Vulpis, president of Amerivest, said the new TDAX Independence ETFs are unique because they're not structured as funds of funds like most target-date offerings. Rather, they invest in proprietary indexes designed by Zacks Investment Research. He touted the low costs, transparency and flexibility of ETFs as a natural fit. The target-date ETFs have expense ratios of 0.65%, compared with about 1.3% for the average comparable mutual fund, Vulpis said.

Each of the new TDAX Independence ETFs tracks a Zacks index holding 500 securities -- 300 U.S. stocks, 100 international developed-markets equities and 100 debt securities.

"We wanted to provide a product that was simple yet diversified, with modest fees," Vulpis said. "We want to help investors with automatic asset allocation and rebalancing, and an ETF was the best way to go about that."

Michael Case Smith, managing director at Zacks IFE, added that the indexes result in lifecycle ETFs that are more aggressive in the "out" years when the target date is distant, by allocating relatively more to stocks than bonds, relative to comparable funds. Meanwhile, the Zacks indexes get relatively more conservative when they get close to the target date, Smith said.

The indexes are more aggressive in the "out" years because people have many more working years ahead, he explained. The benchmarks are more conservative closer to the target date because investors then are concerned with preserving capital, he added.

Pension reform alters landscape

Assets in target-date funds are expected to grow with the passage of the Pension Protection Act. Although the Labor Department is still finalizing its rules, many companies have been automatically enrolling employees in retirement plans. More importantly, target-date funds are seen as logical "default" options if the workers don't choose their investments.

Congress is also considering mandating greater fee disclosure in retirement plans, and the Labor Department is working on improving disclosure between plans and workers.

Tony Dudzinski, chief executive at XShares Advisors, said the indexed ETF structure offers advantages in that regard. He said managers may face conflicts of interest because most target-date funds own in-house funds that may be expensive or have poor performance. The fund of funds structure also layers on extra management fees on top of the expenses for the underlying funds, he said.

Also, ETFs can bring more transparency to the target-date fund market because the holdings are disclosed daily, Dudzinski said.

"Based on what the Labor Department is doing, we see big changes for the retirement plans and defined-contribution markets," the executive said, adding he expects more disclosure on fees that mutual funds pay to retirement plans.

XShares' move into diversified target-date funds is somewhat surprising because the firm is best known for its ETFs that break the health-care industry into narrow slices.

Dudzinski said the company is building multiple business lines and a wider spectrum of products. Last month, XShares listed a family of specialized real estate ETFs with Adelante Shares LLC.

John Spence is a reporter for MarketWatch in Boston.
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Yale university endowment announced their returns for the fiscal year ended June 30. The fund returned 28% compared to 20.7% return for the S&P 500 Index.. This makes them the top performer in their class over the past two decades. Yale has demonstrated that asset class diversification works extremely well and has allocated 28% of the fund to Real Assets (Commodities, Timber, Property, etc.). Large US University endowment funds have been allocating more assets to alternative and commodity assets as a means of diversification and return enhancement. We were at a Wharton leadership conference last spring where the University of Pennsylvania head of endowments broke down how Penn was invested. 22% domestic stocks, 28% foreign stocks, and approximately 30% alternative investments..



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