TSP’s I Fund To See A Much Brighter Future With FRTIB’s Change

May 16, 2018

In November 2017, the Federal Retirement Thrift Investment Board option to expand its I Fund, which included the following: small-capitalization businesses, emerging markets, and Canada.

You can read the full plan by checking out their November meeting minutes. In a nutshell, the board decided that in 2019 the index the I Fund follows will change. The hope is that this will lead to better risk-adjusted returns for the future.

In June 2017, Aon Hewitt, a consulting firm, had spoken with the board, recommending they make the change. The Board agreed to look at what the implications would be in doing this and would address the matter sometime in the fall.

How Is The I Fund Going To Change?

Should the TSP follow through with this planned change, the I Fund will no longer watch the following indexes – Far East Index, Australasia and the Morgan Stanley Capital International Europe. Instead, the index it will follow is the Morgan Stanley Capital International All Country World Ex-US Investable Market Index.

What will this change allegedly do?

Simply put, it would increase the I Fund’s scope.

For instance, the Far East/Europe index the I Fund is currently following has more than 24 percent of the size financed in Japan, with 17 percent financed in Europe. This is a more than 40 percent investment in two leading countries. The seven countries, comprising of 80 percent of the I Fund index, are:

• Australia
• France
• Germany
• Japan
• Netherlands
• Switzerland
• UK

The I Funds’ All Country index is the one the fund will end up following, which only has between 12 percent and 17 percent invested in both the U.K. and Japan. The other countries make up 60 percent of the fund. By making this change, it would mean exposure would be given to South America and Asia and would nearly double the number of countries it will invest in.

Currently, the Far East/Europe index takes into consideration just mid-to-large-sized businesses, which makes up 85 percent of the respective market capitalizations. The All-Country index comprises any sized company (or 99 percent of the market capitalization).

Everything within the TSP funds, except the G Fund, is managed by BlackRock Inc. The company, along with its iShares ETFs charge about the same expense ratios for Far East/Europe and All Country ETFs, which means there shouldn’t be that big of a change happening to the I Fund expense ratio.

What Will The Value Of Emerging Markets Be?

Obvious changes occurring in the I Fund are the additions of small companies and Canada. However, the most notable difference is the inclusion of emerging markets such as Brazil, China, India, South Korea, Thailand, etc. Up to 25 percent of the All Country index is made up of emerging markets; they are not even considered in the Far East/Europe index.

While the “I fund” was regarded as the best TSP fund in 2017, with 25 percent yearly returns, it narrowly missed a 37 percent returns from the emerging markets in that same period. While the performance change is significant for each index every year, there are some indicators that the faster-growing markets will do well over the next ten years. Investors with no exposure are likely to be disappointed if they don’t invest in them.

The International Monetary Fund expects developed economies will see a two percent or less gross domestic product increase in the next five years. Japan, which is the most significant player of the Far East/Europe index, is anticipated to grow less than one percent a year because of two reasons – aging population and declining population. Emerging markets, however, are likely to develop five percent GDP every year.

PricewaterhouseCoopers believes the same thing is to occur. A look at their 2050 outlook notes that the top seven emerging markets were half the size of the top seven markets in 1995 and are currently the same size in 2015. They are thought to be two times the size in 2040. The reasons for this significant change include rising GDP per capita, larger population sizes, and quick population growth.

Along with all this, the Far East and Europe index have had a seven percent exposure in the technology industry, but the MSCIs Emerging Markets index has seen a whopping 27 percent exposure. Thus, the joint All Country index has had a 12 percent exposure to the technology sector.

Adding these economies to the “I fund” would ensure similar effects – the exposure of the technology industry would double.

With exposure like this, one would assume emerging markets would be valuable. In 2007, that happened. According to many metrics like the market-capitalization to GDP- ratios and price-to-earnings ratio, this market would be far more valuable than European or U.S. stocks.

While the yearly returns for the emerging markets haven’t done so well, their corporate earnings and economies have grown. Still, it appears investors see flat returns.

As it stands, emerging markets are still rather valuable even with higher growth expectations for the long-term. Of course, they don’t follow the same indices as other markets, and they trade at lower values than the markets in the U.S., gauging by price-to-book and price-to-earnings.

Developed international markets have similar low values but have extremely low growth in earnings.

The MSCI indices have comparable numbers, with emerging markets seeing low assessments and quicker anticipated growth than international and U.S. stock markets.

What Does It All Mean?

While investors should have international exposure, the kind of index they follow plays a massive role in how well or poor their investment is. Most of them don’t understand how intense the international funds are.

Look at the current set up of the I fund shows that it’s reasonably valued for the short-term, but, looking at the long-term view, it’s liable to miss out on worldwide growth. The heavy concentration of the I fund is focused in Europe and Japan, and adding the emerging markets, Canada, and small companies changes it very little but could have a tremendous impact in the long range.

With the FRTIB’s choice to use the All Country Market Index, the I Fund is going to see more exposure to geographic diversification and worldwide growth. Thus, TSP investors may end up with a much brighter future.