TSP Places Limit on Participant Interfund Transfers

April 28, 2008 (PLANSPONSOR.com) - The debate over methods to stop frequent trading by participants in the Federal Thrift Savings Plan (TSP) has ended as the TSP Board officially amended the plan to restrict interfund transfers.

A rule posted in the Federal Register for April 24 says the plan’s interfund transfer regulations have been amended to limit the number of interfund transfer requests to two per calendar month. Additional interfund transfers can be made only into the Government Securities Investment (G) Fund until the first day of the next calendar month, the rule says.

In the preamble to the regulations, the TSP Board explained the action as follows: “Under the Federal Employees’ Retirement System Act of 1986, the Thrift Savings Plan (TSP) was created to offer passive long-term investments designed to improve the retirement security of Federal employees. As a result of analysis performed in 2007, it became clear that a small number of TSP participants were pursuing “market timing” active investment strategies in the TSP. These activities were diluting the earnings of the long-term investors, and adversely affecting the ability of TSP managers to replicate the performance of selected indexes as required by law.”

A recent analysis by TSP officials on the impact of trading activity on fund management and transaction expenses found the average daily trade in September and October for the fund with the highest costs, the International (I) fund, was $224 million, far above the daily trades of $49 million in 2006 and $27 million in 2005. The officials found the majority of the higher trading volume was due to fewer than 3,000 participants who engaged in frequent trading.

In December members of the TSP Employee Thrift Advisory Council discussed measures other than the interfund transfer restriction that could be used to curb the frequent trading including imposing fees on the frequent traders (See TSP Transfer Restriction Proposal Brings Debate ).

In the published rule, the TSP explained in detail why it rejected comments from participants about the proposed restriction. “By way of summary, those individual respondents who have personally made frequent interfund transfers and oppose the proposed limits display a fundamental misunderstanding of the statutory TSP design. They also present two overarching arguments which deserve discussion at the outset, because they obscure the damage which their frequent IFTs inflict on other plan participants,” the document says.

The TSP noted that the non-random, coordinated actions of fewer than 1% of participants are being made to the detriment of the remaining 99% of participants, and that “the clear intent of this activity–to “beat” the market indexes–fundamentally conflicts with statutory mandates that the Board provide passive investments which replicate the performance of market indexes.”

Some participants argued that it was misleading to compare the TSP funds to mutual funds, but the Board pointed out that TSP assets are invested in Collective Trust Funds which are "virtually identical to mutual funds in the way they are priced and the that trades are executed."

The Board said its decision to restrict transfers was based in part on the fact that the TSP funds are like mutual funds regulated by the Securities and Exchange Commission (SEC) and the SEC found that: "Excessive trading in mutual funds occurs at the expense of long-term investors, diluting the value of their shares. It may disrupt the management of a fund's portfolio and raise the fund's transaction cost because the fund manager must either hold extra cash or sell investments at inopportune times to meet redemptions."

The commenters' claim that frequent interfund transfers do not significantly increase costs is misleading, the TSP said, explaining that the $16 million in trading costs for 2007 was significant compared to the TSP's budget of $87 million and that these costs are born by all participants, not just the few making frequent transfers. The document explained that while the Board has kept the plan's expense ratio to participants very low, the funds also incur transaction costs, which are directly related to the dollar amount of interfund transfers requested by participants. It noted that these transaction costs are investment expenses that reduce investment income before deductions for administrative expenses and are not included in the plan's expense ratio.

Though TSP officials found the highest impact of frequent transfers was made to the I fund, leading some commenters to suggest this should be the only fund with restrictions, the Board noted in the new rule that its analysis also showed adverse effects of frequent trading to other funds. The TSP Board said it was especially troubled by the effect frequent transfers had on the G fund, considered the plan's stable value investment, as it found that some participants were making several trades in one day in and out of the fund, causing a dilution of earnings amounts in the G fund to all participants.

The Board said protecting the intent of the G fund offering is "especially important to those cautious investors who seek security of principle and interest."

In addressing commenters' suggestion to levy a flat fee for interfund transfers, the Board said it decided against such a move because it would be impossible to correctly assign the exact costs of trading to those who are making interfund transfers. The agency explained in detail how trades are made each day using the previous day's closing price, and any difference in total trade amount due to the difference in price on the following day is shared by those participants who did not move monies out of the fund being traded.

In addition, the Board said imposing a fee would deny participants the ability to move to the safety of the G fund at any time without charge.

The new rule in the Federal Register is here .