Q1. Why is the TSP placing limits 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 it moved to the new daily valued system, some participants might engage in market timing activities, the practice was minimal at first.  Although less than one percent of participants averaged more than one interfund transfer per month in 2007, and nearly 85% of participants did not make any IFTs in 2007, a very small number of TSP participants were requesting IFTs to such an extent that the activity began to adversely affect other participants.

For example, in September and October of 2007, the average International Stock Index Investment (I) Fund daily trade amount given to the Investment Manager 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 2007, 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 a small number of TSP participants who are making frequent IFT requests.

Q2.  What are the new limits on interfund transfers?   

For each calendar month, the first two IFTs can redistribute a participant’s account among any or all of the TSP funds.  After that, for the remainder of the month, participants may only move money into the Government Securities Investment (G) Fund (in which case the participant will increase the percentage of the account held in the G Fund by reducing the percentage held in one or more of the other TSP funds).

We will count the interfund transfer based on its process date, not the date the interfund transfer is requested.

If the first or second interfund transfer in a month moves money only to the G Fund, it still counts toward the two (2) unrestricted interfund transfers per month limit.

Q3.  How will these limits affect me? 

Based on current behavior, 99% of TSP participants are not affected by this change.

Q4.  When will the limits be implemented? 

The Agency published a proposed regulation on March 10, 2008.  The opportunity for comment ended on April 9, 2008.  The Agency has considered the comments that were received and has made the decision to implement the limits on May 1, 2008.

Q5.  Do these new interfund transfer limits also apply to contribution allocation requests? 

The interfund transfer limits do not apply to contribution allocation requests.

Q6.  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.

(1) 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 where 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.

(2) 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 benchmark index that each fund tracks has increased.

Q7.  Why does it matter if a TSP fund’s performance differs from the performance of the benchmark index for the fund? 

The performance difference (tracking error) between a TSP fund and its benchmark index can be positive or negative, but the TSP is charged by statute to keep this tracking error as low as possible since the funds must, by law, “replicate” their respective indexes. See 5 U.S.C. § 8438.  Reducing the dollar amount of interfund transfers will lower the amount of cash the investment manager must hold and will therefore reduce tracking error.

Q8.  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 2007, the transaction cost for the I Fund was 6 basis points (or 60 cents per $1,000).  The cost of administering the TSP funds (expense ratio) was 1.5 basis points (or 15 cents per $1,000).  This means that the impact of transaction expenses in the I Fund was four times the impact of the cost of administering the TSP funds.  These costs affect everyone who is invested in the I Fund.  High levels of trading also impacted the other funds.  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 limits on IFTs 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.

Q9.  Why are the transaction costs high? 

As explained in Question 6, 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 one 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 2007, transaction costs for all of the funds were nearly $14 million.

Q10.  The TSP's expense ratio was only 1.5 basis points (.015%) in 2007. 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 $16.5 million reduced the I Fund return by 6 basis points (or .06%) in 2007; net administrative expenses only reduced participants’ returns by 1.5 basis points (.015%) in 2007.

Frequent IFT requests also increase 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.

Q11. The TSP is a huge plan with $216 billion in assets. Why are transaction costs of $16.5 million a problem? 

As indicated in Question 10, transaction costs affect the returns of the funds.  For example, the I Fund's transaction costs in 2007 decreased the I Fund's return by 6 basis points or .06%.  The cost of administering the TSP program was only 1.5 basis points (.015%) in 2007.  The Board is charged with keeping TSP expenses low for all participants. See 5 U.S.C. § 8475. We have determined that IFT limits will result in a significant expense reduction for TSP participants.

Q12.  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, especially compared to the dollar amount of trading activity attributable to participants making frequent IFT requests, is very small.  For example, in the I Fund, for September and October 2007, the average daily dollar amount attributable to the L Funds’ rebalancing accounted for just seven percent of the total daily trade, while the average daily dollar amount attributable to those making frequent IFTs (defined in this instance as participants who have traded in the I Fund eight or more times in the prior 60 days) was 63 percent.  The impact of the L Funds' rebalancing is demonstrably minimal.  The Agency monitors the L Funds, as it does all of its funds; and, in the unlikely event that dollar volume of the L Funds’ rebalancing becomes costly, the Agency can take steps to reduce the frequency or amount of the rebalancings.

Q13.  Why hasn't the TSP already placed limits 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. We decided not to limit the interfund transfers unless a problem developed. In 2007, however, the adverse effects of frequent IFT requests became 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 limits in place.

Q14.  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 limits are not as onerous as the restrictions of other institutions.  For example, one institution restricts transfers 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.” See 71 Fed. Reg. 58258 (Oct 3, 2006).

The TSP concluded that its interfund transfer policy is consistent with best practices in the financial industry and with the guidance provided by the SEC.

Q15.  Why doesn’t the TSP allow a higher number of unrestricted IFTs per month, such as four per month? 

TSP studies showed that allowing four IFTs per month would not result in any meaningful reduction in the dollar amount of the daily trades.  Allowing three per month would result in a 31% reduction and two per month would result in a 53% reduction.

TSP research has shown that less than 1% of participants make more than 12 IFTs per year.  Therefore, the regulation will not affect 99% of participants.  It will allow participants to rebalance their accounts twice per month, which the Plan’s two investment consultants, Mercer and Ennis Knupp, view as more than adequate.

Q16.  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 two percent 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.

In developing its recommendation, the TSP chose not to pursue redemption fees because it is impossible to correctly assign the exact costs to those who are making interfund transfers.  Additionally, imposing a percentage fee would deny our participants the ability to go to the safe harbor of the G Fund at any time for no charge.  The Board considers that capability to be of paramount importance.  A fee-based system would especially punish an infrequent trader who may wish to redeem within 30, 60, or 90 days (depending on the policy) because the market is declining.  In this situation, the participant could face losing two percent of his/her investment in addition to the market decline, a worst case scenario.

Further, our approach is more liberal than most, if not all, of the restrictions reviewed. It allows participants to rebalance up to twice a month. Indeed, our two investment consultants, Mercer and Ennis Knupp, have conducted studies showing that rebalancing an account more than monthly or quarterly is ineffective. We therefore consider our approach to be more accommodating than necessary for optimal rebalancing frequency and demonstrably more liberal than the policies of 40 record keepers which use the same processing system as the TSP.

It is the TSP's intention that allowing participants two unrestricted interfund transfers per month (with unlimited transfers into the G Fund after the first two interfund transfers) will eliminate the extra costs to the TSP that are generated by the transactions of a very small number of participants without affecting the 99% 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.

Q17.  Why doesn’t the TSP limit interfund transfers to 24 per year instead of two per month? 

The purpose of the regulation is to reduce costs to plan participants.  Transaction costs are highest when the markets are the most volatile.  The Agency is seeking to minimize the dollar volume of trades, especially during those times.  With an annual limit, it is likely that a “bunching” of trades would occur during volatile times, precisely the opposite of the intention of the interfund transfer limits.

Q18.  Don’t the IFT limits prevent me from engaging in dollar cost averaging? 

Dollar cost averaging is spending a fixed amount at regular intervals (e.g., monthly) on a particular investment regardless of share price.  Dollar cost averaging is, by definition, not driven by the level of the market.  A participant can most certainly employ a systematic investment plan, making IFTs every two weeks regardless of the performance of the market, just as dollar cost averaging is intended.  In fact, this would essentially be the same frequency of dollar cost averaging into the TSP via deductions from biweekly paychecks.