TSP (Finally) to offer Mutual Funds- Good Idea?

TSP’s Executive Director is having a change of heart.

Recently the Federal Retirement Thrift Investment Board (FRTIB – the group who runs the TSP) announced that it will finally (and they really mean it this time) consider adding a Mutual Fund Window option to the TSP.    FRTIB is commencing a study that will last through 2015 on how best to implement the Mutual Fund Window option.  

In case you have not been following TSP closely, they tend to make decisions at a glacial pace- Congress authorized this change back in 2009.

Some recent facts that swayed TSP’s management in this direction:

• 23 percent of withdrawal participants cited limited TSP choice as their primary reason for withdrawing.
• 45 percent of retired/separated participants withdrew their ENTIRE TSP balances and cited limited choice as the primary reason.
• In 2013, Full Withdrawals from the TSP accounted for $10 Billion.

In light of these facts, TSP / FRTIB is recognizing that an alarming number of TSP participants are ‘firing’ the TSP as their retirement plan once they have the option to do so. It could be due to IRA Rollover Sales Pitches, lack of education, lack of choice within TSP, or any combination of these three factors.

Here’s some more sage advice for TSP – Don’t bother offering Actively Managed Mutual Funds.

On Monday, State Street’s ‘Center For Applied Research’ published “The Folklore of Finance“- A startling reveal of the zero-sum game that is the actively-managed mutual fund industry.  Some key findings of State Street’s research in this 36-page paper:

• The Active Mutual Fund Industry is wildly profitable, but it is not  successful.
• Almost Nobody is achieving Alpha (market-beating returns).

Positive Alpha is a measurement of risk-adjusted return that is better than simply purchasing the corresponding index.  It’s the Holy Grail of active investing and stock picking.  Guys like Peter Lynch and Warren Buffet are famous for producing market-beating Alpha.  However, Positive  Alpha is actually achieved by an astonishingly few managers.  The Industry spends $600 billion per year trying to outperform itself, but fewer than 0.6 percent of 2000 actively managed funds are actually producing any Alpha.

These are not good odds.

Putting it in layman’s terms- If you had the opportunity to invest your retirement fund in the next First-Round-Pick NFL Quarterback, or buy a percentage ownership interest in the entire NFL, which one would you choose?   (Keep in mind that NFL revenues grew from ~$6B in 2005 to $10B in 2013).  Invest in the next Peyton Manning and you’re a genius.  Pick the next Ryan Leaf and your retirement nest egg is vaporized.

You’re not a chicken if you chose to invest in a piece of the entire league instead of Ryan Leaf.  Recently, A VERY BIG investor, CalPERS – The California government employees pension plan – Announced that it has given up on actively managed Hedge Funds. Why?

CalPERS concluded that it was spending too much money in active management fees for essentially nothing in return.

The State Street paper goes on in to a dissertation on Behavioral Finance, which makes for some interesting reading if you have not yet read Dan Areily’s ‘Predictably Irrational’, and the like.    State Street’s ‘Folklore’ study  even includes the following fascinating nugget:

• Nearly 2/3 of individual investors rate their financial sophistication as ‘advanced’.

Yikes.  This is similar to the famous study that 2/3 of all drivers consider themselves to be above average drivers.  Unfortunately, 2/3 of us cannot be correct- 2/3 of us cannot be above average, this is a statistical impossibility.

So is 2,000 Active Mutual Fund managers trying to outguess each other.

GubMints’ advice to the FRTIB –

The Mutual Fund Window is a great idea, and a  much-needed improvement in the TSP.  Add some indices that are not presently on TSP’s menu- REITs, Emerging Markets, and Foreign Bond Funds to start.

…Just don’t bother offering actively managed funds within the TSP.

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