June 22, 2014
In a very interesting development, the FRTIB earlier this year reviewed an analysis of hypothetical returns on the L Funds that included different types of asset classes.
The hypothetical additional asset classes were: an emerging markets fund, an international small cap fund, a global REIT (Real Estate Investment Trust) fund, and a commodities fund.
At first I wondered why a U.S. REIT fund was not included, but then I realized that “international” means non-U.S., while “global” means the entire world including the U.S. I didn’t catch the distinction between the “international small cap fund” and the “global REIT fund” initially. (For example Vanguard has both international and global funds, the former including only non-U.S. assets and the latter including assets based in the U.S.) So I assume the “Global REIT” included both U.S.-based real estate and international real estate.
The analysis tested hypothetical L Fund portfolios that included each of the above asset classes, and one that included all four.
It found that “incorporating additional asset classes generally creates opportunity for higher returns for a given level of risk due to diversification,” and moreover, “of the additional asset classes considered, emerging markets equities have the highest long term return potential.”
(The analysis was based on the new L Fund allocations approved late last year, which increases allocations to the G Fund over the next five years. This is probably why the “new” graphs showing the updated L Fund allocations did not show any difference initially, because it was too soon. It would’ve been helpful, though, to have gotten that specific information up front instead of a ‘here ya go!’ graph for TSP participants to try to figure out…)
Importantly, the analysis also considered various future world economic situations in addition to generally normal conditions. These included: normal growth, recession, stagflation, inflationary growth, ideal growth, credit crunch, and high inflation (10%). Of those, only one scenario is positive. Lots of risks out there…
Projected “real account balances” ranged from $548,000 (best) to $321,000 (worst), obviously reflecting the entire range of upside potentials and downside risks. I couldn’t tell how much salary was going to the L Fund in these hypothetical scenarios, but I would guess between 3% to 5%, the normal range that I’ve seen in studies like these.
This matters to non-L Fund TSP participants, however, since it points to the possibility of additional asset classes being added to those available in the TSP. I couldn’t see how the FRTIB would approve these asset classes for use in just the L Funds, since that would potentially detract from the greater economies of scale to be gained from general availability among all TSP participants.
The Board announced in February that it planned to “further discuss the information in the future.” So at least the idea of adding new asset classes wasn’t disregarded outright!