The Securities and Exchange Commission’s recent decision to start allowing fund companies to create ETF share classes for traditional mutual funds is expected to bring a flood of new ETFs to the market, but State Street Investment Management, the fund management arm of State Street, has other ideas.
The ETF giant, which manages roughly $1.7 trillion in the SPDR ETF family, which includes SPY, the oldest and most widely traded S&P 500 exchange-traded fund, and GLD, the largest gold ETF, sees the SEC’s green light as an opportunity to bring a new ETF challenge to the retirement plan market.
The company plans to reverse the SEC’s decision and offer its ETF strategy’s mutual fund share class to the large U.S. retirement plan market, which is typically closed to ETFs.
Anna Paglia, chief business officer at State Street Investment Management, said Monday on CNBC’s “ETF Edge” that retirement plan markets, where ETFs have not traditionally been represented as a core index fund option, such as the 401(k) and 403(b) markets, are an opportunity and will be a focus, estimating their size at $4 trillion.
Some of the benefits of ETFs, such as more efficient tax trading, may not be important to investors in tax-deferred retirement plans. The intraday valuation of ETFs (ETFs, like stocks, trade in real time throughout the day), as opposed to the once-daily valuation of traditional mutual funds, has also become an issue for some plan sponsors. But State Street’s low fees and large assets under management give it an advantage in offering competitive portfolios to investors and retirement plan sponsors.
“We currently have $1.7 trillion in ETF assets,” Paglia said, explaining that the company can use its existing scale to create more competitive products, regardless of share class. “The enemy of efficiency is fragmentation,” Paglia said.
In a recent Barron’s op-ed that Paglia wrote to explain the company’s thinking, he noted that while the tax efficiencies that draw many investors to ETFs cannot be replicated in the retirement plan market, the so-called “in-kind flows” used in ETF management can lead to lower costs and improved long-term performance for retirement investors.
“The reason is that when large institutions redeem ETF shares, ETFs do not have to sell their investments to raise cash like mutual funds do. Instead, through ‘in-kind’ redemptions, ETF issuers are able to redeem their shares, which are typically market makers or broker-dealers. “Securities can be transferred directly to large institutions. By avoiding open market sales, this process helps reduce underlying portfolio turnover and associated transaction costs, an efficiency that benefits investors in all share classes,” Paglia wrote.
State Street’s largest ETF
SPDR S&P 500 ETF Trust (SPY)
Assets: $698 million
Expense ratio: 0.0945%SPDR Gold Shares (GLD)
Assets: $132 million
Expense Ratio: 0.40% State Street SPDR Portfolio S&P 500 ETF (SPYM)
Assets: $95 million
Expense ratio: 0.02% Technology Select Sector SPDR Fund (XLK)
Assets: $95 million
Expense ratio: 0.08%Financial Select Sector SPDR Fund (XLF)
Assets: $52 million
Expense ratio: 0.08%
Source: State Street
The SEC recently began approving ETF share classes for traditional mutual funds upon application from dimensional fund advisors. The mutual fund industry is expected to move en masse to implement this new ETF provision. More than 70 fund providers have pending applications, and ICI, a major fund industry trade association, recently told ETF Edge that it is working with hundreds of fund companies to prepare to take advantage of the SEC’s exemption relief.
However, the current government shutdown has put further action on hold, including State Street’s plan to make ETFs available as mutual funds in the retirement market. If State Street Investment Management is able to move forward, the question will specifically be which ETFs can stand out in the 401(k) market. Although trading across multiple stock classes improves trading efficiency and cost efficiency, many of the core strategies of the ETF lineup are already offered by State Street for retirement investors in traditional fund portfolio stocks.
And in the asset management industry, where ETFs and index funds from giants like Fidelity Investments and Vanguard Group have driven fees to literally zero, economies of scale across portfolios are already important in competing for investors’ assets. Fidelity already offers four zero-fee core index mutual funds. Vanguard’s S&P 500 ETF (VOO), which hit a record high in annual ETF flows, has an expense ratio of 3 basis points (0.03%). The new version of SPY, State Street’s SPYM, has an expense ratio of 2 basis points (0.02%).
But for many investors, ETFs have become the go-to vehicle for accessing a full range of market strategies, from core stocks to thematic stocks, increasingly narrow slices of the fixed income market, and even alternative investments such as precious metals and cryptocurrencies.
“Mutual funds are a way for ETF-oriented companies to…meet investors where they are,” Todd Rosenbluth, head of research at VettaFi, said of “ETF Edge.”
He noted that State Street is not the only asset manager planning to create an ETF in the mutual fund stock class, with F/M Investments also planning a similar approach to benefit from the SEC’s decision.
Making the world’s largest gold fund more widely available in 401(k) plans at a potentially lower cost comes at a time when many investors are adding larger allocations of gold to traditional portfolios, often at the expense of bond funds. But Rosenbluth said State Street’s biggest opportunity to stand out in the 401(k) market at the individual portfolio level beyond GLD is with select sector SPDRs like XLK and He said it could be a new alternative ETF launched by the company, such as the IG Public & Private Credit ETF (PRIV). Individual investors have access to portfolio strategies that are typically only available to institutional investors.
ALLW, a global multi-asset allocation fund, includes billionaire hedge fund manager Ray Dalio’s Bridgewater Associates as a sub-adviser. Although PRIV was the first ETF with significant private credit exposure to be approved by the SEC, it was not without some controversy.
Mr. Paglia explained that the plan is less about marketing a specific strategy and more about structuring State Street’s fund business to bring the best parts of ETF structures to more markets. “ETF technology is the most efficient technology in this market, but ETF technology is not the right wrapper for everyone,” Paglia said on CNBC’s “ETF Edge.”
“In my view, the retirement industry has not benefited from the innovation that the ETF industry has brought to the market and benefited from,” he added.
The reason for the fragmentation Paglia cited is the fact that there are many legal wrappers around portfolio strategies used across retirement plans, such as collective investment trusts, target-date funds, mutual funds and ETFs.
“My IRA is invested in ETFs, but my 401(k) plan is not,” she said. “This is not about ETFs and mutual funds,” Paglia said. But he added that State Street could take advantage of the size and scale of its ETF business by giving the SEC the power to give asset managers different share classes when the government reopens. “We have the power of scale,” she said. “We have hundreds of strategies, so we also have the power of content. … When you combine content with cost, it’s ultimately something that investors can benefit from.”
