Retail investors have taken a shine to exchange-traded funds in recent years, in large part because of their relatively low cost.

Now, growing corporate concern about the level of 401(k) fees is sparking interest in using ETFs in 401(k) plans.

Invest n Retire, which provides 401(k) plans that invest in ETFs, had $50 million in 401(k) assets at the end of 2006, but CEO Darwin Abrahamson said the firm is on track to boost that to between $500 million and $1 billion by the end of this year.

“It’s the concern about fees,” Abrahamson said about the surge in his Portland, Oregon-based business. “Before, we didn’t have nearly as many plan sponsors that were really looking at their plans and understanding that they needed to know what their fees are.”

Invest n Retire, whose proprietary software allows it to handle the administrative difficulties caused by the differences between ETFs and mutual funds, offers 401(k) plans a lineup of ETFs from seven providers, as well as institutional mutual funds from Dimensional Fund Advisors.

Navmar Applied Sciences Corp., an engineering services company in Chester, Pennsylvania, began using Invest n Retire as its 401(k) provider in November 2004, in part because of the cost advantages of investing in ETFs, according to Mike Kelley, director of administration for Navmar.

The decision worked, Kelley says. Navmar’s 401(k) participants now pay about 75 basis points in fees, down from the 160 basis points they were paying to the previous 401(k) provider, an insurance company.

Abrahamson argues that ETFs are an attractive option for 401(k)s not only because of the lower expense ratios but because they don’t involve any revenue sharing or hidden fees, the kinds of financial arrangements that critics say unfairly add to mutual fund investors’ costs and have led to calls for better disclosure.

According to Morningstar, the average expense ratio for ETFs is 41 basis points, versus 132 basis points for all mutual funds. Given that ETFs are indexed, a more appropriate comparison may be to indexed mutual funds, which have an average expense ratio of 72 basis points, according to Morningstar.

But not everyone is convinced ETFs are a solution to high-fee 401(k)s.

Louis Harvey, president of Dalbar Inc., a Boston-based financial industry research firm, called comparisons between the expense ratios of ETFs and mutual funds “bogus” because they don’t take into account the administrative services covered by many mutual fund expense ratios.

While mutual fund expense ratios are higher, “much of that goes to pay for things like call centers, record keeping and a lot of other services,” Harvey says. Plans that use ETFs instead of mutual funds will end up paying for those expenses in some other way, he adds.

Martha Papariello, a principal in Vanguard’s financial advisor services group, notes that ETFs involve not only an expense ratio but a trading commission, and such commissions can be especially onerous given the regular contributions that occur in a 401(k) plan.

“You’re putting in money every other week; you’re incurring trading costs every other week,” Papariello says. “I find it hard to imagine that with all those additional costs factored in, it’s more economic for participants to get their index exposure that way.”

But Abrahamson says the cost of trading ETFs on an institutional basis is “almost nothing.”

Mike Woods, chief executive of XTF LP, an asset management company whose funds invest in ETFs, agreed that trading costs are low.

“We’re only seeing about two basis points of transaction costs a year; it’s really de minimis,” he says.

More fundamentally, Papariello argues that the intraday trading that is possible with ETFs is inconsistent with the long-term goals of 401(k) investing.

In fact, 401(k) investors would probably have a hard time trading in and out of ETFs these days because 401(k) platforms aren’t set up for it. But Barclays Global Investors, which sponsors iShares, one of the best-known families of ETFs, wants to change that.

Lance Berg, a Barclays spokesman, says the company is working on a solution to the “plumbing problem” that makes it hard to trade ETFs in a 401(k) plan on an intraday basis.

The intention is “not to allow necessarily for active trading, but to allow a plan participant to trade on an investment strategy or some insight they might have, to be able to act on that throughout the day,” he says.

Meanwhile, fund companies are coming out with mutual funds that invest in ETFs.

XTF is set to launch a set of seven Target Date ETF Portfolios. Both J&W Seligman and Federated Investors launched ETF-based target-date funds last year.

But investors who access ETFs via mutual funds may miss out on some of the vaunted cost advantage. Morningstar says mutual funds with “ETF” in the title have an average expense ratio of 98 basis points, more than double the 41-basis-point average for ETFs.

Filed by Susan Kelly of Financial Week, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.