A TSP Checkup

With nearly $450 billion in assets and 5 million participants, the retirement plan for government workers--the Thrift Savings Plan (TSP)--is the largest defined-contribution plan in the U.S. But it's a quiet giant: While the TSP website includes a lot of valuable information for plan participants, the TSP funds are not mutual funds, so you won't see data for them on Morningstar.com or other media outlets. And the funds are index-based, so nor will you see TSP managers telegraphing their views on CNBC or in the Wall Street Journal.

But that doesn't mean that TSP participants aren't keen for information. In the past, I've written about the TSP's many virtues, especially its ultra-low-expense, utilitarian menu of investment options, as well as a few holes in its lineup, which TSP investors can plug using accounts like IRAs. It's time for another review, including a deeper dive into its L funds, the TSP's target-date equivalent.

Cheap Cheap Cheap One of the nice things about the TSP lineup is that it's minimalist and extremely stable. The TSP's core menu includes an S&P 500 index tracker (the C fund), a small-cap stock fund that tracks the Dow Jones U.S. Completion Total Stock Market Index (the S fund), an international-stock fund that tracks the MSCI EAFE Index (the I fund), and a Barclays U.S. Aggregate Bond Index tracker (the F fund). All four of these funds are managed by BlackRock Institutional Trust Company for the TSP.

While it's not difficult to find index-fund equivalents of the aforementioned four funds outside of the government's plan, the TSP also includes what's called the G fund, managed exclusively for TSP participants. The G fund consists of nonmarketable Treasury securities; it's guaranteed not to lose money, but it has historically generated a yield in line with an intermediate-term Treasury fund rather than cash.

The L funds--target-date equivalents managed for investors who are already retired and those who anticipate retirement in or around 2020, 2030, 2040, and 2050--consist of varying mixes of the aforementioned five funds. Like all target-date funds, the near-dated funds are more conservative and equity-light than the funds geared toward investors retiring 20 or 30 years from now.

The defining feature of all of the funds on the TSP menu is their ultra-low costs. According to information on the TSP's website, each of the fund options charged just 0.029% in net administrative expenses in 2014. The TSP is able to swing those low expense ratios because of its enormous scale, as well as the fact that loan fees and forfeitures get thrown into the kitty, thereby putting downward pressure on administrative costs.

Pros and Cons of a Skinny Lineup Yet, as I've noted in the past, the TSP is missing exposure to a few areas that many investors might want as part of their long-term portfolios. While investors can easily marry the S&P 500 C fund with the small-cap S fund to gain exposure to the total U.S. market (a 4 to 1 ratio replicates a total U.S. market index fund), the I fund doesn't include exposure to emerging markets or foreign small caps. Participants in the plan may not have been complaining about that recently: The MSCI EAFE Index that is the basis for the I fund has gained more than 12% on an annualized basis during the past three years, whereas the MSCI Emerging Markets Index has gained just 4% annualized during the same period. But valuations in emerging markets are potentially more attractive than is the case for developed markets right now, so the upside could be better for the former going forward.

The fixed-income lineup also downplays certain bond types that investors might want to be part of their portfolios. There's no direct exposure to Treasury Inflation-Protected Securities, but as this post on the Bogleheads site indicates, the G fund has characteristics that should help TSP investors preserve their purchasing power while also avoiding the price fluctuations (especially in rising-rate environments) that can accompany TIPS.

The combination of the G fund and the F fund, which tracks the Barclays U.S. Aggregate Bond Index, also gives TSP investors a more government-heavy emphasis than is pervasive among core-type intermediate-term bond funds today. That high-quality focus has been a disadvantage as credit-sensitive bonds have outperformed, and it could also prove to be a drag for the F fund in a rising-rate environment, as the Aggregate Index it tracks has a longer duration than the typical actively managed intermediate-term bond fund today.

But it's worth nothing that the G fund and the Aggregate Index (the F fund) have given TSP investors strong protection in equity-market sell-offs. In 2008, for example, the TSP's L (target-date) funds all outperformed their mutual fund category counterparts, in some cases by large margins. The L Income fund lost just over 5% that year, holding its ground thanks, in part, to its high-quality fixed-income portfolio and lighter-than-average equity weighting. Meanwhile, the typical retirement-income mutual fund lost more than 18% that year.

L Fund Review Indeed, the L funds provide a useful lens to assess the TSP lineup's considerable attractions, as well as its potential drawbacks. In general, the L funds' equity allocations are not far from, but generally lighter than, their mutual fund peers in various target-date categories. The L 2040 fund, for example, holds 54% in U.S. stocks and 21% overseas, whereas the typical 2040 target-date mutual fund has 57% of assets in U.S. equities and 28% overseas. Investors using an L fund and who also have a pension or other stable source of retirement income may want to augment their L holdings with additional equity exposure, either inside or outside of the TSP.

The complexion of the L funds' non-equity portfolios is even more noteworthy. All of the funds heavily emphasize the G fund, which provides stability and a yield in line with intermediate-term government bonds, over the F fund, which tracks the Aggregate Index. For example, the L Income fund has 74% of its assets in G, currently, and just 6% in F.

Those biases have influenced performance. Because G guarantees stability of principal, that also means that it cannot benefit when yields trend down; from that standpoint, emphasizing G has put the L funds at a disadvantage alongside target-date products that have benefited from declining yields. Because it's both lighter on equities than other retirement-income funds and also heavy on G exposure, the L Income fund is the only TSP L fund to have underperformed its peers over every longer-term trailing period through December 2014. Of course, G is apt to prove its mettle in a rising-yield environment, both benefiting from rising yields and keeping principal stable.

The longer-dated L funds look much better on the performance front relative to their mutual fund category peers. In fact, L 2020, 2030, 2040, and 2050 were all outperforming their mutual fund category counterparts over longer-term trailing periods through December 2014. The year 2013 was a particularly good one for the L funds, explaining much of their strong relative returns over the trailing periods. Eschewing emerging markets, as the I fund does, certainly helped that year, and the L funds also likely benefited from their lack of inflation hedges, such as TIPS and commodities, which are prevalent in many target-date series and struggled that year. Those biases could work against the L funds at some point in the future, but they have been helpful recently.

In all, TSP participants have an enviably solid, low-cost retirement plan. Getting familiar with the performance patterns that have characterized the lineup's performance in the past--and are likely to influence it in the future--can help TSP participants use it well, and potentially augment it with other non-TSP holdings in their broader portfolios.