TSP I Fund: Shut the Barn Door!

What’s up with the battle over the TSP I fund?

In case you haven’t heard some members of Congress (bi-partisan) do not believe the federal government employee Thrift Savings Plan should invest in China. The FRTIB said they would take it under consideration, asked their consultant (the same one who recommended it in the first place), shrugged their shoulder and said sorry we are still expanding the I fund into emerging markets and international small caps.

For Congress, it is about China – trade war, national security, stolen intellectual knowledge and growing political risk. For FRTIB (their consultant) the answer is that everyone else is doing it. So why not give TSP participants exposure to emerging markets and international small caps since most 401K plans have these great investment opportunities…

…well as long as you don’t look at past performance.

Sure add emerging markets to the I fund…

I’ll side with the members of Congress on this one (maybe a first). I agree with their issues, but my main issue is the lack of audits on Chinese companies. China will not allow anyone to see their audits. And probably with good reason.

You Can’t Trust a Chinese Audit the Wall Street Journal 4 June 2019

Chinese law requires that financial records remain in China, and Beijing restricts access to accounting information, citing national security and state secrecy. Chinese practices raise real risks of fraud… They also undermine the fair and transparent financial reporting at the heart of American capital markets.” —Mr. Rubio, a Republican, is a U.S. senator from Florida.

I have found little consideration in financial circles for national security or even much understanding of what it means, so it is not surprising the answer is simply about what is standard practice. But still would a fiduciary allow investments in companies that can not be audited?

Phantom $4 Billion Joins Accounting ‘Land Mines’ Shaking Chinese Market the Wall Street Journal 20 May 2019

The suspension of Kangmei Pharmaceutical Co. occurred after the market regulator laid out how the Shanghai-listed company had inflated its cash holdings by more than $4 billion, and said it had diverted $1.3 billion into purchasing its own stock.

Separately, auditors for Kangde Xin, the materials company, said last month they couldn’t verify a claimed bank balance of 12.2 billion yuan. Kangde Xin missed interest payments on three bonds earlier this year and said last week that police had detained former chairman Zhong Yu for suspected crimes.

The recent cases show that China’s stock market is “full of land mines,” said Shen Meng, director at Chanson & Co., a Beijing-based boutique investment bank. “Part of the problem is that the cost of violating the law is too cheap here,” Mr. Shen said. The toughest penalty for false financial disclosures is a 600,000 yuan fine.

My simple view is they should delay expanding into emerging markets for now or at least into China But to put China’s inclusion into the I fund into an investment perspective, once added China will account for about 7% of the TSP I fund’s weighting which might climb slightly as MSCI continues to add Chinese companies to their index.

Since the Lifecycle funds invest in the equity funds based on their market cap weighting and the US makes up 55% of the world’s weighting today, China would account for about 3% of the equity allocation within the L funds. Since the highest equity allocation in the L fund is around 80% we are talking less than 3% exposure in even the L2050 fund.

I don’t see three percent exposure as a high risk reason to avoid the TSP L funds. I have avoided the TSP I and L funds for much better reasons up until now. I will simply add to my list for avoidance China’s lack of transparency (investment risk) and stealing US intellectual knowledge along with stealing our industrial base needed to support our military (political risk).

Since I should be balanced, I will add that the expansion will bump up the TSP I fund’s technology exposure from 8% to 12% thanks to China’s tech sector – stolen technology and all. I will also add that international equity markets are not as grossly overvalued as US markets since they don’t have corporations burning $800 billion in cash in open markets buying back their own shares each year.

This simply tells us that a well diversified portfolio that includes international markets will one day lose less than the US markets alone if that gives you a warm diversified fuzzy. The same way that a well diversified portfolio that included international markets gained much less in the past.

Off subject a tad but not really, China managed to take out our military industrial complex without firing a shot. They had help from wall street and CEOs forced to move operations to China to compete internationally. Senator Rubio isn’t even trying to close the barn door after all the animals got out – he’s just trying to shut a little window. And getting resistance.

It does not bode well for what really needs to be done. Thanks FRTIB for getting your financial consultant’s opinion on this.


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Categories: Perspectives