FedSmith has run several articles recently on the new restrictions to be imposed on frequent trading among funds in the Thrift Savings Plan. These articles ranged from Market Timing and Your TSP to Winners and Losers: Frequent TSP Trading, Balancing LifeCycle Funds and Money
There is little doubt that the information will not satisfy those readers who believe strongly they are entitled to trade TSP funds as often as they like. But, at least, anyone reading this information directly from the TSP will be better informed about the new restrictions and their rationale. The information below is unedited and provided by the Thrift Savings Plan.
Why is the TSP placing restrictions on the number of interfund transfers a participant may make each month?
The TSP is a retirement savings and investment plan. Investment choices should be made with a long-term objective based on a participant’s time horizon. Although the TSP recognized that, once we moved to the new daily valued system, some participants might engage in market timing activities, the practice was minimal at first. Now, however, a very small number of TSP participants are engaging in frequent trading to such an extent that it is having adverse effects on other participants.
For example, in September and October of 2007, the average I Fund daily trade amount was $224 million. This compares to average daily I Fund trade amounts of $49 million in 2006 and $27 million in 2005. In September and October, 63% (or $142 million) of the $224 million traded was attributable to participants who had traded the I Fund eight or more times in the prior 60 days. Trade volume is up significantly, and the majority of this increased volume is attributable to less than 3,000 TSP participants who are engaged in frequent trading.
What are the new restrictions on interfund transfers?
The Thrift Savings Plan will implement restrictions on the number of interfund transfers a participant can make per month in order to curb frequent trading and its associated costs to TSP participants. However, the TSP does want to provide the opportunity for participants to rebalance their accounts and to permit unrestricted access to the Government Securities Investment (G) Fund. Accordingly, the restrictions would be as follows:
Participants can make two (2) interfund transfers per calendar month. After that, they may only move money from the Fixed Income Index Investment (F) Fund, the Common Stock Index Investment (C) Fund, the Small Capitalization Stock Index Investment (S) Fund, the International Stock Index Investment (I) Fund, and the L Funds to the G Fund.
We will count the interfund transfer based on its process date, not the date the interfund transfer was requested.
If your first or second interfund transfer in a month moves money only to the G Fund, it still counts toward your two (2) interfund transfers per month limit.
How will these restrictions affect me?
Based on their current behavior, these restrictions would have no impact on the investment activity of 99% of our participants.
When will the restrictions be implemented?
The restrictions will be announced in the annual TSP participant statement mailing which is scheduled for February 2008. We anticipate they will take effect in April 2008.
What has been the impact of frequent interfund transfer activity on the TSP Funds?
Frequent trading activity has (1) increased fund transaction costs and (2) increased the likelihood that a fund’s performance will deviate from its benchmark.
- Transaction costs, which are in addition to the TSP administrative expense for each fund, can be double or triple the cost of administering the fund. Transaction costs are not fees paid to Barclays Global Investors (BGI, the investment manager for the F, C, S, and I Funds). They are costs comprising commissions paid to brokers, transfer taxes, and market impact (the difference between when the stock is bought or sold versus the stock price used to value the fund). Before BGI places an order to buy or sell shares in the market, it trades shares internally among other public and corporate tax-exempt employee benefit plans that are invested in the same index funds as the TSP. There is no cost to the TSP for this service. However, the larger the trade, the lower the percent that can be internally moved between plans. Thus, an increase in the size of the daily trade leads to a disproportionate increase in the transaction costs which are paid by all TSP participants invested in these funds.
- Further, because of the very large dollar amounts being traded, particularly in the I Fund, BGI has had to increase its cash/futures pool to ensure that the funds can meet their daily redemption requirements. As a result, the possibility that the funds’ performance will differ from the performance of the index each fund tracks has increased.
What are the costs to TSP participants invested in the funds affected by frequent trading activity?
Frequent trading activity results in additional fund trading expenses that are borne by all participants in the fund (not just those who are making interfund transfers), and can negatively impact returns.
For example, in 2006, the trading cost for the I Fund was 8 basis points (or 80 cents per $1,000). This means that the impact of frequent trading in the I Fund was more than double the impact from the cost of administering the TSP funds (expense ratio) which was 3 basis points (or 30 cents per $1,000). These costs affect everyone who is invested in the I Fund, not just the frequent traders. The frequent trading is impacting the other funds as well. In addition, there is the possibility of foregone interest in those situations where BGI cannot settle our large trades on a next-day basis.
Thus, the changes are designed to protect the interests of all participants in response to the frequent interfund transfers in the F, C, S, I, and L Funds made by a small number of TSP participants.
Why are the transaction costs high?
As explained in Question 5, transaction costs are not fees charged by the investment manager, but are comprised of brokerage commissions, transfer taxes, and market impact. Brokerage commissions are very low, but in some foreign countries, transfer taxes are very high. For example, Ireland charges a 1 percent tax on all purchases of securities. Market impact is by far the largest transaction cost, particularly in the I Fund where we give our investment manager the order to buy or sell when the overseas markets are closed. The manager then executes the trades when the markets reopen. Any price difference is market impact and there are always price differences. In 2006, transaction costs for all of the funds were over $15 million.
The TSP’s expense ratio was only 3 basis points (.03%) in 2006. Why does the TSP need to limit trading when expenses are already low?
Transaction costs are investment expenses that reduce investment income before deductions for administrative expenses and are not included in the administrative expense ratio. (See the Thrift Savings Plan Statement of Changes in Net Assets Available for Plan Benefits portion of the Plan’s financial statement.) Transaction costs of $13.8 million reduced the I Fund return by 8 basis points (or .08%) in 2006; net administrative expenses only reduced participants’ returns by 3 basis points (.03%) in 2006.
Frequent trading also increases the cash the investment manager must hold to meet redemptions, which leads to a greater chance of differences in performance from the indexes tracked by the funds. It is the goal of the TSP to keep this "tracking error" as low as possible since the funds are designed to mimic their respective indexes.
The TSP is a huge plan with $235 billion in assets. Why are transaction costs of $15 million a problem?
As indicated in Question 8, transfer costs affect the returns of the funds. For example, the I Fund’s transaction costs in 2006 decreased the I Fund’s return by 8 basis points or .08%. The cost of administering the TSP program was only 3 basis points (.03%) in 2006. The Board is charged with keeping TSP expenses low for all participants. We have determined that trading restrictions will result in a significant expense reduction for TSP participants.
Does rebalancing the L (lifecycle) Funds every day cause the amount traded to increase?
The dollar amount of trading activity attributable to the L Funds is very small, especially compared to the dollar amount of trading activity attributable to frequent traders. For September and October 2007, the average trade in the I Fund was $224 million. The L Fund rebalancing accounts for $16 million, while frequent traders account for $142 million. (Frequent traders are participants who have traded in the I Fund eight or more times in the prior 60 days.) Therefore, the impact of the L Funds’ rebalancing is minimal.
Why hasn’t the TSP already placed restrictions on the number of interfund transfers that a participant can make each month?
Before the TSP moved to the daily valued record keeping system, participants were limited to 12 interfund transfers a year – one per month. When we decided to introduce daily valuation, we understood that some participants might trade more frequently. We decided not to limit the interfund transfers unless a problem developed. In the past two years – particularly in the past 6 months, however, the adverse effects of frequent trading have become more pronounced. Because the Federal Retirement Thrift Investment Board has a fiduciary responsibility to all of its participants to keep costs low, the decision was made to put restrictions in place.
Do other plans and mutual funds place trading restrictions on their participants?
The financial industry has responded in a variety of ways to the challenge of frequent trading in its mutual funds. Consequently, most large mutual fund families have adopted some type of trading restrictions or they have implemented a fee structure. The TSP reviewed the restrictions in place for many of these mutual funds and determined that allowing participants two interfund transfers per month, with subsequent interfund transfers only to the G Fund was both reasonable and prudent. (The TSP restrictions are not as onerous as those of some institutions. For example, one institution restricts trades to once every 60 days; another provides for one round trip – an investment into and out of a fund – per year.)
Although the Securities and Exchange Commission (SEC) does not have direct oversight authority with respect to the TSP, its views on frequent trading and its directive to mutual fund boards of directors is instructive. The SEC provides that, under rule 22c-2(a)(1), "the board of directors must either (i) approve a fee of up to 2% of the value of shares redeemed, or (ii) determine that the imposition of a fee is not necessary or appropriate. Id. A board, on behalf of a fund, may determine that the imposition of a redemption fee is unnecessary or inappropriate because, for example, the fund is not vulnerable to frequent trading or the nature of the fund makes it unlikely that the fund would be harmed by frequent trading. Indeed, a redemption fee is not the only method available to a fund to address frequent trading in its shares.
As we have stated in previous releases, funds have adopted different methods to address frequent trading, including: (i) restricting exchange privileges; (ii) limiting the number of trades with a specified period; (iii) delaying the payment of proceeds from redemptions for up to seven days (the maximum delay permitted under section 22(e) of the [Investment Company] Act); (iv) satisfying redemption requests in-kind; and (v) identifying market timers and restricting their trading or barring them from the fund." 71 Fed. Reg. 58258 (Oct 3, 2006).
The TSP concludes that its restriction policy is consistent with best practices in the financial industry and with the guidance provided by the SEC.
Why doesn’t the TSP impose redemption fees instead of trading restrictions?
In deciding what action to take, the TSP conducted a study of the best practices of large mutual fund families, which revealed that two methods are used to control frequent trading: (1) fees and (2) trading restrictions. T. Rowe Price imposes fees on redemptions; it manages an international index fund similar to the TSP’s I Fund and charges investors a fee of 2% for any redemptions made within 90 days of purchase. Fidelity limits international fund activity to one round trip (a purchase and sale) within 30 days, with a maximum of two round trips in any 90-day period. Vanguard, the largest manager of index funds, does not allow any of its funds to be repurchased within 60 days after a sale.
The TSP determined that imposing a 2% fee on redemptions within 90 days would harm the vast majority of participants who are not frequently trading. We wanted to give participants the opportunity to rebalance their portfolios more often than every 90 days. For example, a participant purchases some shares of a TSP fund and decides, for whatever reason, to change that allocation a week later. That may be the only activity in the account that year, but according to the policy at T. Rowe Price, the participant would be charged a fee. Fidelity’s policy essentially allows 4 purchases and sales every 90 days. The TSP proposal is more liberal in allowing 6 purchases and sales in a 90-day period. The TSP also wanted to provide more flexibility than the Vanguard rule, which requires investors to wait 60 days before repurchasing a fund.
It is the TSP’s intention that restricting participants to two interfund transfers per month (with unlimited transfers into the G Fund thereafter) will eliminate the extra costs to the TSP that are generated by the transactions of a very small number of participants without causing harm to the vast majority of participants who trade infrequently. It is a policy that is much more liberal than the policies of many large, well regarded mutual fund families.
Do these new interfund transfer restrictions also apply to contribution allocation requests?The interfund transfer restrictions do not apply to contribution allocation requests.