The TSP’s F Fund was supposed to offer a little more return in exchange for a little more risk

Terry Gerton We have a topic that feels ripped from the headlines, the F Fund in the TSP, all about bonds. And certainly while the bond market in general has been in the news lately with the Treasury Secretary Beset saying he’s buying back bonds, interest rates exceeding historical averages by a long shot. What do all of those headlines have to do with the performance of the F fund in the TSP?

Arthur Stein Well, TSP participants have a choice of whether they want to invest in stock funds or bond funds. And if they invest in the stock funds, which are C, S and I, then those funds take that money and buy stocks for them. And the performance they see of those funds is based upon the performance of stocks they own. With the F fund, that’s a bond fund. And the money that’s invested in the F Fund is used to purchase bonds. Pretty conservative allocation of bonds, about 47% U.S. government bonds and then some corporate bonds, some other things. But that money is used to purchase bonds and the performance of the F fund is based upon the performance of those bonds. Of course, the G fund, which is considered to be maybe a bond fund, maybe a cash account, it’s really more like a bank account than a bond fund. Because there’s no fluctuation in value. And it’s important to remember with the F fund, those bonds do fluctuate in value, there have been years when returns were negative, but the fluctuations in value, what we call volatility, is nowhere near as great as it is with stocks and the stock funds. Now the L funds invest in all five of the traditional funds, but a very small portion goes to the F fund and a much, much larger portion to the G fund for the bond allocation of the L funds.

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Terry Gerton Art, the F Fund has lagged the G Fund really over the last 10 years, so for a federal employee who’s looking and trying to understand those numbers, what’s driving that F Fund performance these days?

Arthur Stein So the F Fund’s always been unpopular. In 2009, the F and the S Fund, which is a US stock fund, were the least popular with only about 5% of TSP funds invested in those two. As of May of this year, F was by far the least popular with 1.9% of funds invested directly into F. So, you know, I’ve been helping federal employees and retirees for way more than 30 years. And my impression was always that they didn’t like F because they knew it was volatile. And G seemed like such a good deal. So even many years ago, when the F Fund was really doing well, and in most years outperforming G, they just didn’t want to be bothered with it. They wanted complete security, which is what g offered compared to f.

Terry Gerton The F fund used to be the place to get a little more return than the G fund, while kind of staying relatively conservative. Would you say the role of the F fund has changed in a portfolio or has the market environment changed around it?

Arthur Stein Now the performance of the F fund is driven by the interest paid by the bonds that it owns, but also by fluctuations in bond prices. And bond prices, we’re talking about existing bonds, which is what’s owned by the F Fund, go up and down constantly based upon changes in interest rates. So, you know, every hour, every minute, you’re going to get some fluctuation value. The index that drives the F fund, it’s based on an index. It’s the Bloomberg-Barclay’s US aggregate bond index. So it’s put together by an outside firm, the same thing’s true, C, S, I funds, and that is just a very conservative bond index. Now for a long time, you know, the F Fund did very well and that’s because in the late ’70s, early ’80s, U.S. interest rates started to decline. And they continued to decline until about two years ago, three years ago. And so, F fund most of the time outperformed G. But starting a couple of years ago was really in 2021, more like five years ago, interest rates in the U.S. Started to trend upward. 2022 was the worst year for the bond market, maybe in U.S. history. We saw double digit declines in bond prices and that included 2022 performance of the F fund. It was down 13% in 2022 after a 1.5% decline in 2021. So if you look like at any kind of average annual rate of return over any time period that includes ’21 and ’22, F fund looks terrible. It underperformed G. Over all those time periods, but it’s primarily or maybe completely driven by what happened in 2021 and especially 2022.

Terry Gerton Arthur Stein is a partner with Allworth Financial. So Art, with that background and history, why should feds even think about putting their money into F, if G is out producing it and feels more stable? Is there a role for F in a balanced portfolio?

Arthur Stein Okay, it’s not necessary. You know, the most important decision that TSP participants make is what percentage of their investments is going into the stock funds compared to F and G, the bond funds. And that is really going to drive how well they do. I think that for employees who are investing weekly, if they’re going to have a portion of their money, go to bonds. Then I would say, you know, don’t put it all in G, put some in F because prices are down and you want to buy low. And the interest rate, the yield being paid by the bonds in the F fund now has gone up. So it’s a good time to buy. But I would not make a big argument for that. I mean, they’ve got the G fund. The question is they want to feel safe enough to put money in the stock fund. Now, if they’re using the L funds, some of their money will be in F. Some portion of that bond allocation will be invested in F automatically and then they don’t have to worry about it.

Terry Gerton What would you be looking for in the bond market to create the conditions where it might return back to favor and start rewarding investors the way many people kind of expected it would a while back?

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Arthur Stein Yeah, it’s really what happens to interest rates, Terry. If we reach a point where interest rates have topped out and we expect them to level off and then hopefully decline, that’s when F becomes a really good investment.

Terry Gerton We’ve just heard the national debt passing the $40 trillion mark, and Treasury perhaps trying to buy back some of that. But given that the Treasury’s now managing a federal debt load that’s much larger than it’s been, even when many listeners started investing, does the scale of that borrowing change the outlook for bond investors?

Arthur Stein Absolutely, yes. Because, you know, those large deficits, and they’re huge, of course, tend to drive interest rates higher. And that means that the price of existing bonds is going to decline, which means that the F fund would have poor performance because it owns lots of existing bonds. And that’s, you know, I don’t like to forecast and never try and forecast. But I would say that interest rates are more likely to go up than down. I don’t think that’s a bold prediction. I think most people would be very surprised if we went into a long term where interest rates were declining.

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