Independent 

advice for 

the institutional 

investor 

Investment Option 

Review 

for the 

Federal Thrift 

Savings Plan 

October 2006 INVESTMENT OPTION REVIEW 
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G:\TSP\WP\Option Review\Investment Option Review 

_FINAL_10_2006.doc 

CONTENTS 

1 Executive Summary 

2 Review of Current Circumstances and 

Comparison to Peers 

3 Investment Structure 

4 Key Evaluation Criteria for Investment Fund 

Alternatives 

5 Application of Key Criteria to Investment Fund 

Alternatives 

6 Non-U.S. Bonds 

7 U.S. Stock 

8 Emerging Markets Stock 

9 TIPS 

10 REITs 

11 Commodities 

12 Recommendations 

13 Appendix 
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EXECUTIVE SUMMARY 

 Ennis Knupp + Associates 1.1 

The Federal Retirement Thrift Investment Board (FRTIB) asked Ennis Knupp + Associates to review the current 

investment structure of the Thrift Savings Plan (TSP), i.e., the number and types of investment funds offered to 

participants, and evaluate potential investment fund additions. In this report, we: 

 Review the current circumstances of the TSP and compare its practices to peer plans 

 Identify key criteria for evaluating investment fund alternatives 

 Apply the key criteria to a broad array of investment fund alternatives to identify investment funds 

appropriate for consideration 

 Review appropriateness of adding specific investment fund alternatives 

 Provide our recommendations to the FRTIB 

Below we summarize the key points of our report: 

Current Practices and Comparisons to Peers

The key points of the TSP’s investment structure and comparison to peers are highlighted below. 

 

 The TSP offers participants five core investment options (G, F, C, S and I Funds) that reasonably span the 

risk-return spectrum, allowing participants to construct portfolios that range from low to moderate to higher 

risk. 

 The L Funds allow participants to select an investment fund(s) that is diversified among and within asset 

classes, as the L Funds are constructed using the five core investment funds. 

 With 10 investment options (5 core funds and 5 L funds), the number of investment options available to 

participants is generally comparable to peers. 

 The TSP offers investment funds in the categories that are found in the majority of participant-directed 

defined contribution plans -- stable value (G Fund), bonds (F Fund), U.S. stock (C and S Funds), non-U.S. 

stock (I Fund), and lifecycle/balanced funds (L Funds). 

 The types of investment funds that receive the majority of participants’ assets in peer plans are comparable 

to those used by TSP participants. 

 While peer plans may offer a wider array of investment funds, the non-core investment funds do not typically 

receive a significant portion of participant assets. 

 TSP participants are offered the type of investment funds predominantly used by participants in peer plans. 

Importantly, participants are offered five core investment options that span the risk/return spectrum and are 

offered the option of selecting pre-mixed portfolios (L Funds) that reflect different risk/return characteristics 

and embrace the key principles of investing – diversification among and within asset classes, low cost, 

rebalancing to maintain target portfolio weights, and target weights that evolve as an investor’s time horizon 

shortens.
EXECUTIVE SUMMARY 

 Ennis Knupp + Associates 1.2 

Our review of the program leads us to the conclusion that the core of the investment program is well-structured 

and there are no gaps in the investment line-up. 

Investment Structure

We believe a plan’s investment options should offer a sufficient range of choice to allow participants to form welldiversified portfolios, given a reasonable range of risk and return circumstances. As such, we believe that the 

TSP should have a structure that: 

 Offers sufficient range of choice – with options that reasonably span the risk and return spectrum 

 Allows participants to form well-diversified portfolios 

 Is appropriately comparable with peers 

 Meets broad participant demand 

The investment fund types offered to TSP participants match those we recommend the TSP offer. 

 U.S. stock 

 Non-U.S. stock 

 Diversified fixed income 

 Cash equivalent/stable value 

 Lifecycle 

Our recommendations regarding the TSP’s investment structure are also influenced by our beliefs that: 

 Employee education is one of the most important components of a successful defined contribution plan 

 The number of options should not overwhelm participants 

 The more broadly diversified an asset class/asset category, the better it will serve participants over the longterm 

 Participants should be provided with two decision-making paths – an array of lifecycle funds and an array of 

broadly diversified asset class/asset category specific funds 

Key Criteria For Evaluation of Investment Fund Alternatives 

In evaluating the types of investment fund alternatives to offer in the TSP, we believe the following criteria 

(individually and collectively) are the most relevant to consider: 

 Major diversified asset class/category not currently offered as an investment option 

 Asset class/category is large enough for the TSP to invest in 

 Potential diversification benefit for TSP participant portfolios 

 Index fund products are available 

 Practices of peers
EXECUTIVE SUMMARY 

 Ennis Knupp + Associates 1.3 

Application of Key Criteria

We identify the following asset classes/categories for evaluation: 

Equities Fixed Income Alternatives/Other 

U.S. Growth Stock Non-U.S. Bonds Private Real Estate 

U.S. Value Stock High Yield Bonds Private Equitiy 

Real Estate Investment Trusts Treasury Inflation-Protected Securities Commodities 

Emerging Market Stock Hedge Funds 

Non-U.S. Small-cap Stock Socially Responsible/ Corporate 

Governance Funds 

After applying the key criteria, we eliminated the following asset classes/categories from further consideration: 

 Non-U.S. small-cap stock 

 High yield bonds 

 Private market real estate 

 Private equity 

 Hedge funds 

 Socially responsible/corporate governance funds 

We then reviewed the merits of offering the following investment fund alternatives in detail: 

 Non-U.S. bonds 

 U.S. stock funds by valuation 

 Emerging markets stock 

 Treasury Inflation-Protected Securities (TIPS) 

 Real Estate Investment Trusts (REITs) 

 Commodities 

Asset Classes/Categories Evaluated in Detail

Our key thoughts on the six asset classes/categories we reviewed in detail are outlined below. 

Non-U.S. bonds 

While non-U.S. bonds are a material portion of the world’s investable market capitalization, the benefits of 

adding a non-U.S. bond fund are minimal from an expected risk-return and portfolio diversification standpoint for 

TSP participants. Moreover, adding a non-U.S. bond fund would add complexity to a segment of the plan where 

we believe additional flexibility is not required and/or meaningful. We recommend the FRTIB not add a non-U.S. 

bond fund as an investment fund alternative. 

Value and Growth U.S. Stock Funds 

We examined the potential addition of larger-capitalization growth and value stock funds, but did not find this a 

compelling alternative as TSP participants have significant exposure to those segments already; the TSP’s 

investment line-up currently provides broad exposure to the entire U.S. stock market via the C and S Funds. 
EXECUTIVE SUMMARY 

 Ennis Knupp + Associates 1.4 

Emerging Markets Stock 

While emerging markets are a large asset class, expected to experience secular growth and provide a benefit to 

portfolios at the highest levels of risk, we have concerns with the TSP offering emerging markets as a stand 

alone investment fund due to its high level of risk. The high risk associated with emerging markets has resulted 

in material losses over relatively short periods of time and is difficult for participants (or for any investor) to bear. 

Additionally, there are limited benefits to adding an emerging markets investment fund for well-diversified low to 

moderate risk portfolios. 

Overall, we believe the negatives of offering an emerging markets investment fund outweigh the positives and 

recommend an emerging markets fund not be added as an investment fund alternative. We believe it is 

appropriate to monitor the possibility of accessing the emerging markets via the I Fund in the future as index 

providers may offer a daily valued index fund that provides exposure to both the developed non-U.S. stock 

markets and emerging markets in their respective proportions. 

TIPS 

TIPS are attractive to investors who want to hedge inflation. The TSP, however, offers a fund (G Fund) that 

provides similar inflation-hedging characteristics over the long-term without negative price volatility, which 

diminishes the benefits of offering a TIPS option. Additionally, a TIPS option would provide limited diversification 

benefits to TSP participants, add complexity to an investment category where we believe additional flexibility is 

not required and is not common practice among peer plans. We recommend that the FRTIB not offer TIPS as 

an investment fund alternative. 

REITs 

We recommend the FRTIB not offer REITs as an investment fund alternative. Our recommendation is based on 

the fact that REITs are a sub-sector of the U.S. stock market, TSP participants currently can obtain exposure to 

REITs via the C and S Funds, the addition of REITs does not significantly improve TSP participant portfolios, 

and it is not common practice among peers. Overall, we believe the negatives more than outweigh the primary 

potential positives of REITs, historically low correlation of returns to the current TSP investment funds. 

Commodities 

Commodity futures offer a diversification benefit, as well as the potential to hedge against inflation. However, 

commodity prices are influenced by demand/supply considerations rather than the intrinsic value of securities, 

and future return expectations are uncertain. Most individual investors will have difficulty in determining an 

appropriate allocation to commodities, and commodities have a concentration in the energy sector. It is also not 

a common investment option in defined contribution plans. We recommend that the FRTIB not offer commodities 

as an investment option in the TSP. 

Recommendation

We did not find any of the six asset classes/categories that we evaluated in detail particularly compelling as 

investment fund additions. We recommend the FRTIB not add any additional investment funds to its investment 

program. 

Our analysis follows. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.1 

The following section encapsulates the current circumstances of the TSP's investment structure and compares it 

to peer plans. 

Overview 

 Assets of approximately $194 billion as of September 30, 2006 

 Over 3.6 million participants 

 An average participant balance of approximately $54,000 

 10 investment options currently available to participants 

Fund Type TSP Fund 

− Stable Value G Fund 

− Diversified Fixed Income F Fund 

− Lifecycle/Balanced L Income 

 L 2010 

 L 2020 

 L 2030 

 L 2040 

− U.S. Stock C Fund 

 S Fund 

– Non-U.S. Stock I Fund 

Key Characteristics of TSP 

 The TSP offers participants the ability to invest in five diversified “core” investment alternatives (G, F, C, S 

and I Funds) that reasonably span the risk return spectrum, allowing participants to construct portfolios that 

range from low risk to moderate to higher risk. We note the G Fund is not “diversified” among securities but 

is backed by the full faith and credit of the U.S. government. 

 The L Funds allow participants to select an investment fund(s) that is diversified among and within asset 

classes, as the L Funds are constructed using the five underlying core investments funds. Importantly, the L 

Funds embrace the key principle of investing in that they are broadly diversified. The L Funds rebalance and 

evolve over time from growth-oriented portfolios to income and principal-preservation focused portfolios in 

order to adjust for participants’ time horizons. 

 The costs of administering the TSP’s investment options are well below industry average at less than 

0.05%. Investment fees for most other plans range from 0.50% to 0.80%. We rarely observe total 

investment fees below 0.45% for participant defined contribution plans. 

 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.2 

On the following pages, we compare the practices of the TSP to those of peer defined contribution plans. In 

order to compare the TSP to an appropriate sub-set of peers, we use information from three widely followed 

defined contribution marketplace surveys – Profit Sharing/401(k) Council of America (PSCA), Hewitt Associates, 

and CRA RogersCasey. 

Using the PSCA 49th Annual Survey of Profit Sharing and 401(k) Plans and data from CRA RogersCasey, we 

first compare the number of options offered to TSP participants to those offered by other plans. 

Number of Investment Options Offered 

 PSCA 

TSP 

Plans with 5,000 + 

Participants All Plans 

CRA 

RogersCasey 

One to Five 2.1% 2.3% 7.0% 

Six 2.2 0.9 3.0 

Seven 2.2 1.6 7.0 

Eight 0.7 1.5 2.0 

Nine 5.8 3.3 5.0 

Ten X 8.0 6.6 13.0 

Eleven to Fifteen 48.2 38.3 37.0 

Sixteen to Twenty 14.6 22.6 18.0 

Twenty-One + 16.0 23.0 8.0 

Source: PSCA 49th Annual Survey of Profit Sharing and 401(k) Plans (2005 Plan Experience); CRA RogersCasey Annual Defined 

Contribution Survey 2004 

Observations 

 The median number of investment options offered is eleven to fifteen. While the number of options offered 

has increased since the early nineties, the average number of options utilized by participants (approximately 

4 options according to Vanguard and Fidelity participant studies) has not kept pace. 

 With 10 investment options, the number of choices available to TSP participants is generally comparable to 

peer plans. 

 As it stands, TSP participants are offered ample opportunity to diversify their assets, and the current plan is 

generally competitive with regard to the number of investment options offered. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.3 

The table below shows the types of investment options commonly offered to participants. 

Investment Options Commonly Offered 

Fund Type TSP 

Plans with 

5,000+ 

Participants All Plans 

Balanced Fund No 65.6% 67.5% 

Actively Managed Bond Fund No 59.2 64.2 

Bond Index Fund Yes – 1 36.8 28.9 

Cash Equivalents No 48.0 50.4 

Company Stock No 56.0 21.3 

Actively Managed U.S. Stock Fund No 80.0 80.0 

U.S. Stock Index Fund Yes – 2 80.0 71.3 

Actively Managed Non-U.S. Stock Fund No 75.2 74.8 

Non-U.S. Stock Index Fund Yes – 1 28.8 22.6 

Lifestyle/Asset Allocation Fund Yes – 5 49.6 50.2 

Real Estate Fund No 8.0 18.8 

Self-directed (brokerage/mutual fund window) No 24.8 22.6 

Stable Value Fund Yes – 1 76.0 58.8 

Other No 18.4 24.5 

Source: PSCA 49th Annual Survey of Profit Sharing and 401(k) Plans (2005 Plan Experience) 

Observations 

 The TSP offers funds in the categories that are typically found in the majority of defined contribution plans – 

stable value (G Fund), bonds (F Fund), U.S. stock (C and S Funds), non-U.S. stock (I Fund) and balanced 

and/or lifestyle/asset allocation funds (L Funds). 

 The investment categories that are offered in more than 50% of peer plans where the TSP does not offer 

investment options is not a deficiency. The TSP offers a fund in a similar category or is unable to offer a 

fund in the category. We discuss this further below: 

3⁄4 While 64% of all plans offer an actively managed bond fund, it is not necessary for the TSP to offer 

this type of fund as the F Fund provides exposure to the asset class and the TSP has historically 

offered only index funds to its participants. 

3⁄4 It is not necessary for the TSP to offer a cash equivalent fund as it offers the G Fund, which 

provides the key characteristics sought in a money market fund – i.e., liquidity and preservation of 

capital. 

3⁄4 Company stock is offered in 56% of plans with more than 5,000 participants. This consideration is 

an irrelevant point as the TSP does not have the ability to offer company stock. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.4 

3⁄4 Actively managed U.S. stock funds are offered in the majority of plans (80%). The TSP has not 

offered actively managed U.S. stock funds as it has not been allowed to do so by statute. It is not 

necessary for the TSP to offer actively managed funds as the TSP has provided broad exposure to 

the U.S. stock asset class via the C and S Funds. 

3⁄4 Actively managed non-U.S. stock funds are offered in the majority of plans. It is not necessary for 

the TSP to offer actively managed funds as the TSP provides participants access to this asset 

class via the I Fund. By statute the TSP is only able to offer a passively managed fund. 

In the following tables, we show the participant asset allocation practices according to the three marketplace 

surveys mentioned earlier. 

PSCA: Participant Asset Allocation 

Plans with 

5,000+ 

Participants 

Allocations 

Excluding 

Company Stock TSP 

Cash Equivalents 4.0% 4.8% -- 

GIC/Stable Value 14.5 17.3 37% 

Actively Managed Bond 3.6 4.3 -- 

Bond Index 1.6 1.9 5 

Total Fixed Income 23.7% 28.3% 42% 

Company Stock 16.0 -- -- 

Actively Managed U.S. Stock 23.4 27.9 -- 

U.S. Stock Index 11.2 13.3 42 

Actively Managed Non-U.S. Stock 5.8 6.9 -- 

Non-U.S. Stock Index 1.5 1.8 9 

Total Stock 57.9% 49.9% 51% 

Balanced 6.8 8.1 -- 

Lifestyle/Asset Allocation 6.0 7.1 7 

Real Estate 0.2 0.2 -- 

Self-directed 1.9 2.3 -- 

Other 3.5 4.1 -- 

TOTAL 100.0% 100.0% 100% 

Source: PSCA 49th Annual Survey of Profit Sharing and 401(k) Plans (2005 Plan Experience) 

Observations 

 TSP participants’ allocation to stocks is lower than that of its peers; however, after normalizing the peer data 

for company stock, the allocation to stocks is comparable. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.5 

The table below shows the asset allocation practices of plans with 40,000+ participants according to Hewitt 

Associates’ 2005 survey. 

2005 Hewitt Associates’ Survey: Participant Asset Allocation 

Fund Type 

Plan Site 

40,000+ Participants 

Allocations Excluding 

Company Stock TSP 

Money Market 2% 3% -- 

GIC/Stable Value 16 23 37% 

Bond 3 4 5 

Total Fixed Income 21% 30% 42% 

Company stock 30 -- -- 

Large-cap U.S. stock 15 21 35 

Mid-cap U.S. stock 2 3 7 

Small-cap U.S. stock 6 9 -- 

Non-U.S. stock 4 6 9 

Emerging Market stock <1 <1 -- 

Total Stock 57% 39% 51% 

Balanced 11 16 -- 

Life Style/Asset Allocation 10 14 7 

Specialty sector <1 <1 -- 

Self-directed window <1 <1 -- 

TOTAL 100% 100% 100% 

Source: Hewitt Associates: How Well Are Employees Saving and Investing in 401(k) Plans (2006 Hewitt Universe Benchmarks) 

Observations

 The large allocation to company stock indicates participants in these plans generally have a high degree of 

security specific risk. This is not an issue with TSP participants. 

 If the results are normalized to TSP’s circumstances, and we assume that over 50% of balanced/lifecycle 

funds are allocated to equities, the equity allocations are more comparable to those of the TSP. 

 More specialized asset classes/categories are not commonly used by participants. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.6 

The table below shows the asset allocation practices of plans with more than $500 million in assets according to 

CRA Rogers Casey. 

CRA Rogers Casey Annual Defined Contribution Survey 

Average Asset Allocation For Plans With More Than $500 Million in Assets 

Fund Type 

Plans with >$500 

million in assets 

Allocations 

Excluding Company 

Stock TSP 

Cash equivalents/money market 2% 3% -- 

Stable Value 21 30 37% 

U.S. Bond, Active 3 4 -- 

U.S. Bond, Passive 1 1 5 

Non-U.S. Bond <1 <1 -- 

Total Fixed Income 27% 38% 42% 

Company stock 25 0% -- 

U.S. Large-cap, active 15 21 -- 

U.S. Large-cap, passive 11 15 35% 

U.S. Mid-cap stock 2 3 7 

U.S. Small-cap stock 3 4 -- 

Non-U.S. stock, active 3 4 -- 

Non-U.S. stock, passive <1 <1 9 

Global Stock <1 <1 -- 

Emerging market stock <1 <1 -- 

International small-cap stock <1 <1 -- 

Specialty sector <1 <1 -- 

Total Stock 61% 48% 51% 

Balanced 4% 6% -- 

Lifestyle/Lifestage 5 7 7% 

REITs <1 <1 -- 

Mutual fund window <1 <1 -- 

Self-directed brokerage <1 <1 -- 

Other 1 1 -- 

TOTAL 100% 100% 100% 

Source: CRA RogersCasey Annual Defined Contribution Survey 2004. 

Observations 

 The survey data indicates that the types of investment options that receive the majority of participants’ 

allocations, excluding company stock, are similar to those of TSP participants. 

 While plans may offer a wider array of investment funds, these options seldom receive a significant portion 

of participants’ assets. 
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.7 

The graph below shows the historical risk-return characteristics of the TSP’s current investment funds. Returns 

are shown on the X-axis and risk (annualized standard deviation of return) is shown along the Y-axis. The L 

Funds (target retirement date / lifecycle funds) were introduced in August 2005 and comprise of varying 

proportions of the G, F, C, S, and I Funds. The risk and return characteristics of each L Fund is derived from the 

performance of the underlying components comprising the L Fund, based on the underlying component weights 

within each Fund as of December 31, 2005. 

As shown, the investment funds currently offered to participants span the risk-return spectrum from low to high 

risk. 

Summary 

TSP participants are offered the type of investment funds predominantly used by participants in peer plans. 

Importantly, participants are offered five core investment options that span the risk/return spectrum and are 

offered the option of selecting pre-mixed portfolios (L Funds) that reflect different risk/return characteristics and 

embrace the key principles of investing – diversification among and within asset classes, low cost, rebalancing to 

maintain target portfolio weights, and target weights that evolve as an investor’s time horizon shortens. 

Our review of the program leads us to the conclusion that the “core” of the investment program is well structured 

and there are no “holes” in the investment line-up. We believe, however, it is worthwhile to review potential 

alternatives that may afford more investment flexibility to participants and/or an ability to create superior 

portfolios. 

Risk-Return

18 Years Ending 12/31/2005

L2040 L2030

L2020 L2010

L Income

I Fund

C Fund S Fund

F Fund

G Fund

T-Bills

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0

Annualized Risk (%)

Annualized Return (%)
REVIEW OF CURRENT CIRCUMSTANCES AND COMPARISON TO PEERS 

 Ennis Knupp + Associates 2.8 

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INVESTMENT STRUCTURE 

 Ennis Knupp + Associates 3.1 

Having discussed TSP’s circumstances and how it compares to peers, we now review the factors that impact 

participant behavior and our thoughts on how to best implement an investment option structure from a “macro” 

perspective. 

Investment Structure 

The investment structure of a participant-directed defined contribution plan refers to the number and type of 

options offered to participants. This is the most important component of the investment program. It will not only 

determine the structure of investment options offered to participants but will also: 

 Shape how participants invest their assets 

 Impact the participants’ perceived value of the Plan 

We believe a plan’s investment options should offer a sufficient range of choice to allow participants to form welldiversified portfolios, given a reasonable range of risk and return circumstances. As such, we recommend that 

the TSP have a structure that: 

 Offers sufficient range of choice – with options that span the risk and return spectrum 

 Allows participants to form well-diversified portfolios 

 Meets broad participant demand 

 Is appropriately comparable with peers 

We recommend that at a minimum the TSP offer the investment option types listed below. The investment option 

types provide representation of all major asset classes typically considered suitable for defined contribution 

plans and allow for representation of different levels of risk: 

 U.S. stock 

 Non-U.S. stock 

 Diversified fixed income 

 Cash equivalent/stable value 

 Lifecycle 

The TSP currently offers at least one broadly diversified “core” investment fund in each of these categories. 

We generally recommend offering only a single option in the cash equivalent/stable value, diversified fixed 

income, and non-U.S. stock categories, as one option is all that is necessary to provide the asset class exposure 

required to diversify participant portfolios. Additionally, participants’ allocations to these categories are typically 

modest (<10% of assets). 

The two categories where it is appropriate to consider multiple options are lifecycle and U.S. stock. It is 

appropriate to offer multiple lifecycle funds as a program must meet the needs of participants with materially 

different time horizons (e.g., 5 years vs. 35 years). 
INVESTMENT STRUCTURE 

 Ennis Knupp + Associates 3.2 

Offering multiple options in U.S. stock is appropriate for the following reasons: 

 Participants’ knowledge of U.S. stock investing has grown tremendously in recent years – resulting in 

increased demand for U.S. stock fund alternatives. 

 As U.S. stock is generally one of the largest components of a participant’s portfolio, a subset of participants 

typically want to customize their defined contribution plan U.S. stock portfolios to account for personal 

(taxable and tax-exempt) investments, complement investment funds available in a spouse’s plan and/or 

account for their own investment preferences/risk tolerance. 

 It represents contemporary practice. 

The types of U.S. stock funds that we generally recommend offering are: 

– Core stock index fund 

– Larger-cap value 

– Larger-cap growth 

– Mid/small-cap stock 

The TSP does not offer separate large-cap growth and value fund options. We note, however, that participants 

have access to the entire U.S. stock market, including growth and value stocks, via the C and S Funds. 

Guiding Principles

There are three guiding principles we recommend our clients generally employ in structuring their investment 

fund line-ups. These guiding principles are: 

 Employee education is one of the most important components of a participant-directed defined contribution 

plan. Therefore, the less complex the program is, the higher the likelihood of a successful education 

program, as participants tend to get overwhelmed if there are too many options 

 The more broadly diversified an asset class, asset category, investment style, etc., the better it will serve 

participants 

 The investment options of an investment program should be structured/communicated to participants so 

they have two paths from which to choose – an array of pre-mixed lifecycle funds and an array of broadly 

diversified asset class/category specific funds 

Number of options: Surveys and studies by Fidelity, Hewitt Associates, Vanguard and academics cite that the 

greater number of options offered, generally the lower a plan’s participation rate and/or the fewer number of 

investment funds utilized. The unintended consequences of offering too many funds to participants is that 

instead of selecting the appropriate fund(s) they become overwhelmed and delay their decision to participate. In 

many cases, they end up not participating at all, or make no investment decision and are mapped to the plan’s 

default fund. 
INVESTMENT STRUCTURE 

 Ennis Knupp + Associates 3.3 

Broadly Diversified Funds: We generally recommend our clients offer participants investment funds that are 

broadly diversified by security, sector, industry, etc. This assists in avoiding large losses due to an undue 

concentration in a sector, industry and/or security and assists participants in building broadly diversified 

portfolios. 

Tiering of Investment Options: We recommend that clients communicate their lifecycle and asset 

class/category funds as different decision paths or “tiers”. The first path or tier is populated with lifecycle funds 

and is intended for participants uncomfortable in or not inclined to making investment decisions. Participants are 

able to then focus on the lifecycle fund that best suits their time horizon. 

The second tier is comprised of the asset class/category specific funds where participants are able to select and 

mix funds in order to build portfolios that best suit their needs. 

Summary 

The TSP’s current practices are reflective of our general advice on how to best structure a participant-directed 

defined contribution plan. The investment options are well-diversified, the number of options offered in each 

category, except for U.S. stock and lifecycle funds, are limited to one, and participants have two “paths” or “tiers” 

to select from when making their investment decisions. 
INVESTMENT STRUCTURE 

 Ennis Knupp + Associates 3.4 

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KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.1 

In this section of the report, we discuss the key criteria we use to evaluate whether or not an asset class or asset 

category should be considered as an investment fund for inclusion in the Thrift Savings Plan (TSP). We use this 

criteria to narrow the asset classes/categories we reviewed in-depth as potential alternatives. 

Evaluation Criteria

While there are numerous criteria to consider when evaluating the types of investment alternatives to offer in a 

participant-directed defined contribution plan, we believe the following criteria (individually and collectively) are 

among the most relevant for the TSP to consider: 

 Major diversified asset classes/categories not currently offered as investment options 

 Asset class/category is large enough for the TSP to invest in 

 Potential diversification benefit for TSP participant portfolios 

 Index fund products are available for TSP use 

 Practices of peers 

We discuss these criteria in more detail below. 

Major Diversified Asset Classes/Categories Not Currently Offered to Participants 

We believe it is worthwhile to consider the major diversified capital markets that are not currently offered to TSP 

participants. The TSP currently provides participants the ability to invest in three of the world’s largest capital 

markets (U.S. stock, U.S. bonds and non-U.S. developed markets stock), but not all (e.g., non-dollar 

denominated debt or emerging market stock). For the major diversified asset classes not currently offered to 

participants, we believe reviewing the rationale why such an asset class/category would or would not be an 

appropriate asset class/category to add as an investment option is prudent. 

Our review takes into account the advantages and disadvantages of offering an asset class/category individually 

as well as how it could potentially allow participants to form overall better portfolios. 
KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.2 

Asset Class/Category is Large Enough for the TSP to Invest In

Given the extraordinary asset size of the TSP, any investment alternative offered should represent an asset 

class/category of such significance that the likelihood of the TSP becoming a disproportionately large investor 

and trader of the asset class/category is minimized. Several of the measures we evaluate are: 

 Size of the asset class/category in terms of market capitalization 

 Liquidity of the market/category 

 Sector diversification within the asset class/category 

 Number of securities that comprise the market /category 

The criteria we will use within this category include: 

Large Capital Market: We define a large capital market by its total market capitalization (the aggregate value of 

the securities that comprise the asset class/category). We believe the appropriate threshold to use for the TSP is 

a minimum market capitalization of $1 trillion. This is an important consideration as the extraordinary asset size 

of the TSP (almost $200 billion and growing) could cause it to own a large portion of a market that is less than $1 

trillion in asset size if participants were to allocate just 10% of the Plan’s assets to a smaller-sized asset 

class/category. Moreover, the fact that the TSP offers daily liquidity to its participants and participants have 

transferred substantial assets into and out of its options (e.g., $300 million) in a single day implies that TSP 

participants could trade an abnormally large amount of a small market in a single day and significantly impact 

prices. The market capitalization of each of the benchmarks for the TSP Funds exceeds $3 trillion. 

F Fund C Fund S Fund I Fund 

Fund benchmark Lehman Brothers 

Aggregate Bond 

Index 

S&P 500 Stock 

Index 

Dow Jones Wilshire 

4500 Index 

Morgan Stanley 

Capital International 

(MSCI) Europe, 

Australasia, and Far 

East Stock Index 

Market 

capitalization of 

benchmark 

$8.2 trillion $11.1 trillion $3.2 trillion $9.8 trillion 

Number of 

securities 

6,300+ 500 4,400+ 1,100+ 
KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.3 

Liquidity: At TSP’s current size, the average daily cash flows in and out of its investment options are quite large 

on an absolute basis. Of particular concern are days wherein cash flows in or out of a particular fund can spike 

significantly. For instance, the average daily cash flow for the I Fund was $49 million over the past year. On 26 

occasions the cash flows exceeded $100 million and on 5 occasions they exceeded $200 million. Markets such 

as those currently represented by the C, S, I and F Funds are large and liquid enough to accommodate those 

trades on a daily basis. For instance, 100% of a $200 million trade in C and I Funds constitutes less than 10% of 

the average daily volume (ADV) of securities in their respective market, i.e. in the case of the C and I Funds, the 

number of shares of each individual security to be purchased as part of a $200 million trade constitutes less than 

10% of the total number of shares of that security traded daily, on average. For a $200 million trade in the S 

Fund, 96.7% of the trade constitutes less than 10% of the average daily volume (ADV), while 99.8% constitutes 

less than 20% of ADV. 

Some markets/sectors may not be able to absorb large trades without impacting prices in a direction that is 

adverse to participants. If there is excessive demand to buy a stock relative to its supply, it will drive the price of 

the stock higher temporarily, and vice versa, resulting in a “buy high, sell low” outcome. Trades that constitute a 

large portion of the ADV can be expensive; traders generally don’t want to be more than 10%, and at most 20% 

of the ADV in any security. 

While markets/sectors, per se, may be liquid, they may not be liquid enough for very large trades, such as those 

experienced by some of the TSP Funds. Liquidity of markets is more relevant and important to the TSP than to 

almost any other defined contribution plan. 

Sector/Security Diversification: As we discussed earlier, we believe it is important for defined contribution 

plans to offer broadly diversified investment options to participants so as to potentially limit the impact of large 

losses on their portfolios. One way to avoid overly concentrated portfolios is to offer options that are diversified 

by sector, industry and security. Asset classes/categories that are comprised of numerous sectors, industries 

and securities assist in avoiding large losses as the performance drivers of these sectors, industries and 

securities are different or diversified. 

It was not more than seven years ago when participants and plan sponsors were requesting and demanding 

technology focused investment options. For those plans that offered this type of option and participants who 

invested in these funds at the height of the technology bubble, the result was disastrous. This example illustrates 

the danger that underlies offering investment options that are focused specifically on certain sectors, industries 

and/or securities. 
KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.4 

Index fund products are available for TSP use

We review the availability of daily valued index products within the asset class/category. This is a relevant 

criterion as the TSP has historically only offered index products and any product that the TSP may offer needs to 

offer daily liquidity so that it integrates easily with the plan administration. As you will see, many asset 

classes/categories do not offer daily valued products or a very limited set of daily valued products, and/or no 

daily valued index product is currently available. 

Diversification Benefit

We also review the potential “diversification benefit” that adding an asset class/category could benefit participant 

portfolios. The diversification benefit is the risk reduction and/or return enhancement an asset class/category 

could provide by adding it to portfolios at various risk levels. Asset classes/categories that benefit portfolios 

generally have low correlations relative to the investment funds currently offered and competitive historical and 

expected risk-return characteristics. 

Practices of Peers

In making decisions about the number and types of investment options to offer in a participant-directed defined 

contribution plan, it is worthwhile to be aware of contemporary practices. This serves as a guide as participants 

will likely compare the type of options offered in their plan to those of their spouse, friends, and neighbors. 

This does not mean that the TSP should be compelled to offer funds just because peer plans offer certain fund 

types. Rather the types of options to consider should represent a diversified opportunity set that may provide 

participants exposures not currently available and allow them to form better portfolios. 

As we discussed earlier in this report, the TSP offers the types of options that are found in the majority of defined 

contribution plans and the allocations of TSP’s participants to “core” investment options is comparable to that of 

peers. 

Asset Classes/Asset Categories Under Consideration

Based on the criteria we’ve outlined, we segregate the asset classes/categories that we will review into 

 broad asset classes/categories not currently offered to TSP participants 

 asset classes/categories that TSP participants have exposure to via the current investment options, but not 

as a separate fund option 

 specialty categories that do not fall under the first two categories 
KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.5 

The broad asset classes/categories currently not available to participants in any way that we will review are: 

 Non-U.S. bonds 

 High yield bonds 

 TIPS 

 Emerging market stock 

 Non-U.S. small-cap stock 

 Real estate (private market) 

 Private equity 

 Commodities 

The asset categories that are not explicitly offered to TSP participants currently, but participants are able to 

obtain some exposure to via the current investment options offered are: 

 U.S. value stock 

 U.S. growth stock 

 REITs 

The types of investment options that do not fall under the above two segments that we will review are: 

 Socially responsible/corporate governance funds 

 Hedge funds 
KEY EVALUATION CRITERIA FOR INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 4.6 

(This page left blank intentionally) 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.1 

In this section of the report, we apply the criteria developed to the asset classes/categories identified in Section 4 

of our report. 

Application of Criteria

In determining the asset classes/categories that the TSP should consider as potential additions to its array of 

investment funds offered to participants, we first conduct a broad scope review of the possible additions. The 

purpose of the initial broad scope review is to determine which asset classes/categories are worthwhile to review 

in-depth and those asset classes/categories that should be eliminated early on in the process. Factors 

considered included whether: 

 the asset class/category benefits participants’ portfolios meaningfully 

 the asset class/category has a small market capitalization 

 the class/category is unduly concentrated 

 daily-valued index products are not available 

 it is an common investment option among peer plans 

The asset classes/categories we initially review are: 

Equities Fixed Income Alternatives/Other 

U.S. Growth Stock Non-U.S. Bonds Private Real Estate 

U.S. Value Stock High Yield Bonds Private Equity 

REITs TIPS Commodities 

Emerging Market Stock Hedge Funds 

Non-U.S. Small-cap Stock Socially Responsible/ 

 Corporate Governance Funds 

 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 

Screening Criteria: U.S. Stock, REITs and Non-U.S. Stock Asset class/asset category 

Current 

Investment 

Fund provides 

exposure to: 

Fund specific 

to asset 

class/category 

currently 

offered 

Large market 

capitalization 

>$1 trillion 

Diversified by 

sector, 

industry and/or 

securities 

Liquid market Meaningful 

portfolio 

diversifier: 

correlation of 

<0.5 relative to 

current TSP 

stock funds 

U.S. growth equities Yes No Yes Yes Yes No U.S. value equities Yes No Yes Yes Yes No Public real estate/REITs Yes; 1% of C and 5% of S 

Funds 

No 

No; market 

capitalization is 

approximately 

$400 billion 

Yes – security 

Yes – industry 

No - sector 

Yes; but may be an 

issue for TSP if 

cash flows exceed 

$100 million 

Yes 

Emerging markets 

No No Yes Yes 

Yes, but may be an 

issue for TSP if 

cash flows exceed 

$100 million in a 

day 

No, moderate 

benefit as 

correlations to 

C, S and I 

Funds are <0.8 

Non-U.S. smallcap 

Yes No 

No; 

approximately 

$700 billion 

Yes 

Yes, but may be an 

issue for TSP if 

cash flows exceed 

$100 million in a 

day 

No, moderate 

benefit as 

correlations to 

C, S and I 

Funds are <0.8 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 

Screening Criteria: Fixed Income Asset class/asset category 

Current 

Investment 

Fund provides 

exposure to 

Fund specific 

to asset 

class/category 

currently 

offered 

Large market 

capitalization 

>$1 trillion 

Diversified by 

sector, 

industry and/or 

securities 

Liquid market Meaningful 

portfolio 

diversifier: 

correlation of 

<0.5 to current 

TSP bond 

funds 

Da

ind

is 

Non-U.S. bond No No Yes Yes Yes No High yield No No No; market 

capitalization of 

$900 billion 

Diversified, but 

has been 

concentrated in 

certain sectors 

and securities 

historically 

 Yes, but may 

be an issue for 

TSP if cash 

flows exceed 

$100 million in a 

day 

Yes, low 

correlation to F 

Fund 

Ye

o

TIPS No No No; market cap 

of $370 billion 

No; not a major 

issue as 

securities are 

backed by the 

full faith and 

credit of the 

U.S. 

government 

 Yes, but may 

be an issue for 

TSP if cash 

flows exceed 

$100 million in a 

day 

No; high 

correlation to F 

Fund 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 

Screening Criteria: Real Estate, Private Equity and Alternatives/Other Asset class/asset category 

Current 

Investment Fund 

provides 

exposure to 

Fund specific to 

asset 

class/category 

currently offered 

Large market 

capitalization: 

>$1 trillion 

Diversified by 

sector, industry 

and/or securities 

Liquid market Portfolio 

diversifier: 

correlation to 

current funds is 

<0.5 

D

ind

Private real estate 

No No Yes 

Yes – security 

Yes – industry 

No - sector 

No 

Yes; due to its 

appraisal based 

valuations 

Private equity 

No No No Yes No 

Not applicable; 

appraisal based 

valuations made 

Commodities 

No No 

Yes via futures 

instruments 

Yes Yes; most futures 

markets are liquid 

Yes 

Hedge funds No; active 

management 

strategy 

No Not applicable; 

not an asset class 

Not applicable; 

not an asset class 

No; most vehicles 

allow limited 

liquidity 

Not applicable; 

not an asset class 

per se 

Socially responsible investing/corporate governance No No 

Not applicable; 

SRI is not a 

separate asset 

class and 

represents a style 

of investing 

Yes 

Not applicable; 

difficult to 

measure as it 

represents a style 

of investing 

Not applicable 

unknown 

No

rep

of 

se

act

o
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.5 

Below we discuss the information provided in the tables on pages 5.2 - 5.4 and provide our rationale why we 

believe an asset class/category should or should not be further considered as an investment fund option. In 

sections 6 to 11 of this report we provide an in-depth review of the asset classes/categories we believe are 

worthwhile to examine in detail. 

U.S. Stock

We review investment fund alternatives in U.S. stock by style (value and growth). 

We highlight our rationale for reviewing U.S. stock investment funds by valuation below: 

 Larger-cap growth and value market segments are substantial with $6.5 trillion and $6.3 trillion market 

capitalizations, respectively 

 The market segments are diversified by sector, industry, and securities 

 Index products from the major index providers are available 

 These market segments are liquid 

 Peer practice: a majority of plans offer large-cap growth and value fund options to participants 

 Allows participants to better customize their TSP portfolio so that it complements their “total portfolio” – i.e., 

taxable investments, non-TSP retirement investments and spouse’s assets – to better suit their 

circumstances 

We do not review small cap value and growth funds. As each of these markets is relatively small (less than $1 

trillion in market capitalization), the TSP could face liquidity issues if cash flows exceed $200 million in a day. 

Participants have access to these segments via the S Fund, and the amount of assets indexed in this category is 

modest. 

We discuss the merits of offering large-cap growth and value funds in Section 7. 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.6 

REITs

We review the merits of adding REITs as an investment option.

We review REITs as a potential investment fund alternative for the following reasons: 

 REITs have relatively low correlations to the current TSP Funds and have performed well in recent periods 

 REITs have grown substantially in market capitalization in recent years 

 The major index providers offer REIT index funds 

 REITs have garnered much attention over the last several years 

We address REITs in Section 10 of this report. 

Non-U.S. Stock

We review the merits of offering an emerging markets stock fund. 

We eliminate a non-U.S. small-capitalization stock fund from further consideration. 

As the I Fund is a large- to mid-cap diversified non-U.S. developed markets index fund, we review two potential 

additions to the TSP investment line-up, emerging markets stock and non-U.S. small-cap stock. 

Emerging Markets

We believe it is appropriate to review the merits of an emerging markets stock fund for the following reasons: 

 Large market with total capitalization of $2.0 trillion 

 Emerging markets are diversified by country, sector, industry, and securities 

 TSP participants do not currently have exposure to emerging markets 

 Daily valued index products are available 

 Expectations that emerging markets will provide exposure to some of the world’s most rapidly expanding 

economies 

There are a number of issues that warrant further discussion regarding the risks of offering an emerging markets 

stock fund, which include volatility of returns, market liquidity and that the majority of peer plans do not offer this 

fund type. We discuss the merits of adding an emerging markets stock fund in Section 8. 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.7 

Non-U.S. Small-cap Stock

We eliminate a non-U.S. small-cap stock fund from further consideration for the following reasons: 

 Modest-sized market: MSCI EAFE small-cap has market capitalization of less than $700 billion 

 No daily valued non-U.S. small-cap stock index fund is offered by the major index providers 

 Non-U.S. small-cap funds are not common practice among peers 

Adding non-U.S. small-cap stocks provides limited diversification benefits relative to current investment funds 

offered. 

Fixed Income

We review in-depth the merits of adding a non-U.S. bond fund and a TIPS fund. We eliminate a high yield 

bond fund from further consideration. 

There are three major fixed income asset classes/categories to review for potential addition to the TSP: 1) nonU.S. bonds, 2) high-yield bonds and 3) Treasury inflation-protected securities (TIPS). We believe it is appropriate 

to further review the merits of non-U.S. bonds and TIPS, but not high yield bonds. 

Non-U.S. Bond

We believe it is appropriate to further review non-U.S. bonds for the following reasons: 

 Large market: non-U.S. bonds represent approximately 20% of the world’s market capitalization at over $18 

trillion 

 TSP participants do not currently have any exposure to this substantial asset class 

 Non-U.S. bond market is well-diversified by country, maturity and issuers 

 Non-U.S. bonds have a low correlation to stocks 

We discuss the merits of offering a non-U.S. bond fund in Section 6. 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.8 

TIPS

We believe it is appropriate to further consider TIPS for the following reasons: 

 Large and growing market: while the market capitalization of TIPS is less than $1 trillion, the market has 

grown substantially in recent years (from $0 in 1997 to $370 billion today) 

 TSP participants do not currently have exposure to TIPS 

 Real return plus inflation tracking component of TIPS are attractive characteristics to many investors 

 TIPS offer modest portfolio diversification benefits to a broadly diversified portfolio 

 While TIPS are not diversified by issuer, their creditworthiness is backed by the full faith and credit of the 

U.S. government 

 Daily valued index products are available from major index providers 

We review the merits of offering a TIPS investment fund in Section 9. 

High Yield Bonds

We do not believe high yield bonds warrant further consideration for the following reasons: 

 While the high yield market is relatively large at $900 billion, the market has been concentrated in various 

industries over time (casinos, cable, autos). For example, autos comprise over 10% of the high yield market 

currently 

 Composition of market is driven by issuers – i.e., the high yield market’s composition is not necessarily a 

result of demand by investors as the market’s composition may result from sector/industry issuance and/or 

downgrading of former investment-grade issuers (e.g., Ford and GM) 

 One daily valued index product currently exists; generally only actively managed products are available 

 Management of a broadly diversified high yield bond index fund is problematic in that the index manager 

may need to hold securities that are in the process of defaulting or are in default 

 While the high yield bond market is relatively liquid, the TSP may have liquidity issues if daily cash flows 

exceed $100 million 

 High yield bonds offer only a modest diversification benefit 

 High yield bond funds are not common practice among peers 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.9 

Private Market Real Estate

We eliminate private market real estate from consideration. 

While we generally advocate that our defined benefit plan clients invest in real estate, we eliminate private 

market real estate from further consideration. No daily valued private market real estate index fund exists. We 

are aware of two daily valued real estate products that are available to defined contribution plans, but these 

products place material redemption restrictions on large investors, which would be an issue for the TSP. 

Moreover, these products are actively managed and no passive alternative is viable as portions of individual 

properties would need to be held and priced daily.

Private Equity

We eliminate private equity from further consideration. 

Private equity is broadly defined as venture capital, leveraged buyouts, mezzanine financing, distressed debt 

and special situations. We eliminate private equity from further consideration for the following reasons: 

 Private equity investment vehicles are highly illiquid, and the assets are valued infrequently - a major issue 

for TSP administration 

 No daily valued index product currently exists 

 Private equity investments cannot be passively managed 

 Private equity represents a small proportion of the world’s overall market capitalization 

 Private equity is not a common investment type offered to participants 

Hedge Funds

We eliminate hedge funds from further consideration. 

While hedge funds have garnered billions of dollars in assets over the past several years, we recommend 

eliminating hedge funds from further consideration for the following reasons: 

 The hedge fund category is not an asset class in and of itself; rather hedge funds represent a broad array of 

active management strategies 

 No daily valued index fund of hedge funds exists 

 The majority of hedge funds do not offer daily liquidity 

 Hedge funds are not a common investment offering in peer plans 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.10 

Commodities

We evaluate the merits of offering commodities as an investment option. 

We believe it is worthwhile to review commodities as a potential investment option for the following reasons: 

 No explicit exposure via current TSP offerings 

 Diversified among different types of commodities (e.g., oil, metals, grains) 

 Commodities can be a strong portfolio diversifier 

 Large and liquid market 

There are a number of issues that warrant further discussion regarding the risks of offering commodities, 

including the index’s concentration in energy and that the majority of peer plans do not offer this fund type. We 

discuss the merits of adding a commodities fund in Section 11. 

Socially Responsible/Corporate Governance Funds

 We eliminate socially responsible investment (SRI) funds from further consideration. 

While SRI investing has gained in popularity over the years, we eliminated SRI from further consideration for the 

following reasons: 

 SRI is a style of investing that can be implemented passively, but the selection of the SRI issue(s) is an 

active decision to exclude or include a security/company – an approach the TSP has not employed 

previously 

 Application of “social” screening (e.g., tobacco) could conflict with allowed practices under Federal Law 

 Identification of an issue(s) would likely draw attention from opposing parties of interest – i.e., difficult to find 

“perfect” common ground 

 SRI funds are not common practice among peers 

 SRI did not meet most of the screening criteria established 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.11 

Summary 

We evaluate the merits of offering the following investment fund alternatives in-depth: 

 Non-U.S. bonds 

 U.S. stock funds by valuation 

 Emerging markets stock 

 TIPS 

 REITs 

 Commodities 

We conduct an in-depth review of these asset classes/categories in Sections 6 through 11. 

We eliminate the following asset classes/categories from further consideration: 

 Non-U.S. small-cap stock 

 High yield bonds 

 Private market real estate 

 Private equity 

 Hedge funds 

 Socially responsible/corporate governance funds 
APPLICATION OF KEY CRITERIA TO INVESTMENT FUND ALTERNATIVES 

 Ennis Knupp + Associates 5.12 

(This page left blank intentionally) 
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.1 

We review the merits of offering a non-U.S. bond fund as an investment fund alternative. The primary rationale 

for reviewing non-U.S. bonds includes the significance of non-U.S. bonds in terms of size and the fact that it is 

diversified by security and issuer. We review the asset class in greater detail and provide our recommendation 

as to whether the FRTIB should offer a non-U.S. bond fund.

Market Size

As shown in the graph below, non-U.S. bonds comprise over 20% of the world’s market capitalization with over 

$18 trillion in assets. 

Total Investable Capital Market

December 31, 2005

Real Estate

6.2%

U.S. Bonds

24.5%

High Yield Bonds

1.0%

Non-U.S. Bonds

21.4%

Emerging Market Debt

2.9%

Cash Equivalents

4.1%

All Other Stocks

20.6%

Emerging Market

Stocks

1.8%

U.S. Stocks

16.8%

Private Capital

0.6%

Source: UBS Global Asset Management, Venture Economics, EnnisKnupp

$93.7 Trillion
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.2 

As one of the world’s largest capital markets, it is appropriate to review whether or not the TSP should offer this 

asset class as a stand alone investment fund. Below we discuss the relevant factors to consider in making this 

decision, such as historical risk-return characteristics, potential diversification benefits and index product 

availability. Earlier in our report we noted that non-U.S. bond portfolios were not commonly offered in peer plans. 

Historical Performance of Non-U.S. Bonds 

In the table below, we show the historical returns of currency unhedged and currency hedged non-U.S. bonds. 

We show the returns of the CitiGroup World Government Bond Index (CWGBI) as this is the most widely used 

non-U.S. bond index. We also show the returns of the Lehman Brothers Aggregate Bond Index (benchmark for 

the F Fund) for comparative purposes. 

Annualized Returns (As of June 30, 2006) 

Trailing Years

CitiGroup World 

Government Bond 

Index (Unhedged)

CitiGroup World 

Government Bond 

Index (Hedged)

Lehman Brothers 

Aggregate Bond 

Index

1 -0.4% -0.1% -0.8% 

3 4.2 2.6 2.1 

5 8.5 4.4 5.0 

10 5.4 6.5 6.2 

15 7.2 7.3 6.9 

20 7.6 7.3 7.4 

21 Years 6 Months (since inception) 9.0 8.0 8.3 

The long-term performance of the CWGBI unhedged and hedged indexes is comparable to that of the Lehman 

Brothers Aggregate Bond Index. The large fluctuations in returns on a calendar year basis for the unhedged 

CWGBI relative to the hedged CWGBI and the Lehman Aggregate Bond Index are a result of the performance of 

the U.S. dollar relative to foreign currencies. 

The table below shows the volatility (annual standard deviation) of the indexes over several trailing periods. 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Years 

Citigroup World 

Government Bond 

Index (Unhedged) 

Citigroup World 

Government Bond 

Index (Hedged) 

Lehman Brothers 

Aggregate Bond 

Index 

5 7.2% 2.9% 4.0% 

10 6.7 2.9 3.6 

15 6.5 3.1 3.9 

20 6.7 3.3 4.1 

21 Years 6 Months (since inception) 7.0 3.5 4.4 

The higher level of volatility of the CWGBI unhedged Index is largely a result of foreign currency performance 

relative to the U.S. dollar. 
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.3 

Sharpe Ratios for each of the indexes over various periods are shown below. The Sharpe Ratio is a measure of 

reward per unit of risk (volatility of return) – the higher the Sharpe Ratio the better. 

Sharpe Ratios (As of June 30, 2006) 

Trailing Years 

Citigroup World 

Government Bond 

Index (Unhedged) 

Citigroup World 

Government Bond 

Index (Hedged) 

Lehman Brothers 

Aggregate Bond 

Index 

5 0.91 0.86 0.78 

10 0.33 1.11 0.79 

15 0.58 1.22 0.87 

20 0.50 0.90 0.76 

21 Years 6 Months (since inception) 0.65 0.98 0.87 

Over the longest periods shown, the Sharpe Ratio for the Lehman Aggregate Bond Index is superior to that of 

the unhedged CWGBI, but lower than that of the hedged CWGBI. 

As the historical returns of the unhedged CWGBI are comparable to those of the hedged CWGBI and Lehman 

Aggregate, but risk is nearly double that of the other indexes, the unhedged CWGBI is unappealing. 

We show the correlations of the unhedged and hedged CWGBI returns relative to the returns of the TSP’s 

current investment funds in the table below. Correlation coefficients can range from +1 to -1. A correlation of +1 

between two indexes implies that the returns of the two indexes move in the same direction and in the same 

proportion, while a correlation of -1 means that the returns move in opposite directions but in the same 

proportion. Low to negative correlations generally imply a risk diversification benefit. 

Correlations (18 years ending December 31, 2005) 

C Fund S Fund I Fund F Fund G Fund 

CWGBI 

Hedged 

CWGBI 

Unhedged 

C Fund 1.00 

S Fund 0.98 1.00 

I Fund 0.62 0.62 1.00 

F Fund 0.18 0.16 0.08 1.00 

G Fund 0.01 0.02 0.09 0.14 1.00 

CWGBI Hedged 0.17 0.14 0.12 0.88 0.12 1.00 

CWGBI Unhedged 0.05 0.04 0.36 0.54 0.22 0.57 1.00 

The overall low correlations of the hedged and unhedged CWGBI to the C, S and I Funds seem appealing at 

first. However, the F Fund also has low correlations to the C, S and I Funds. Additionally, the hedged CWGBI is 

highly correlated to the F Fund, and even the unhedged CWGBI has a modestly high correlation with the F Fund, 

indicating that little diversification benefit is to be had from adding non-U.S. bonds. 
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.4 

In the graphs below we show the historical efficient frontier for TSP participants using the current TSP 

investment options and the efficient frontier if the hedged and unhedged CWGBI were part of the investment 

line-up. 

The efficient frontier is the mix of different funds that provides the highest expected return for a given level of risk 

or the asset mix with the lowest level of risk for a given return. 

Efficient Frontier (Based on Historical Data)

Current Options (with WGBI Unhedged; Jan 1988 - Dec 2005)

C Fund

I Fund

F Fund

G Fund

T-Bills

WGBI Unhedged

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0 5.0 10.0 15.0 20.0 25.0

Risk (%)

Return (%)

Current Options Current Options (with WGBI Unhedged)

S Fund

Efficient Frontier (Based on Historical Data)

Current Options (with WGBI Hedged; Jan 1988 - Dec 2005)

C Fund

I Fund

F Fund

G Fund

T-Bills

WGBI Hedged

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0 5.0 10.0 15.0 20.0 25.0

Risk (%)

Return (%)

Current Options Current Options (with WGBI Hedged)

S Fund
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.5 

There is little difference in the historical efficient frontiers for the TSP’s current investment fund and those that 

include unhedged or hedged non-U.S. bonds as investment fund alternatives. 

The table below shows the amount of assets indexed to non-U.S. bonds by the three largest institutional index 

fund managers, Barclays Global Investors (BGI), Northern Trust Global Investments (NTGI), and State Street 

Global Advisors (SSgA). 

Non-U.S. Bond Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

Citigroup World ex-U.S. 

Government - - $227 

JP Morgan Gov't Bond Index 

Global - $34 2,063 

Citigroup World Government 

Bond Index $802 - 1,869 

Non-U.S. Bond Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA* 

Citigroup World ex-U.S. 

Government - - - 

JP Morgan Gov't Bond Index 

Global - $34 - 

Citigroup World Government 

Bond Index - - - 

*Daily valued DC asset information was not readily available from SSgA 

As shown above, non-U.S. bond index funds have a minimal level of assets invested. 

Considerations 

We generally advocate that our clients offer only one investment fund alternative in the diversified fixed 

income/bond fund category. We advocate simplicity in the bond category as participants generally do not 

allocate significant assets to bond funds and do not obtain material benefits from specialized bond funds if they 

have a broadly diversified portfolio. Additionally, it can be difficult to educate participants regarding the drivers of 

a specialized bond fund’s performance (interest rate sensitivity, credit spreads, currency fluctuations, etc.). 

Non-U.S. bond funds are not common practice in peer plans and TSP participants are offered material portfolio 

diversification benefits via the F and G Funds. 
NON-U.S. BONDS 

 Ennis Knupp + Associates 6.6 

Conclusion 

While non-U.S. bonds are a material portion of the world’s market capitalization, the benefits of adding a nonU.S. bond option are minimal from an expected risk-return and portfolio diversification standpoint for TSP 

participants. Moreover, adding a non-U.S. bond fund would add complexity to a segment of the plan where we 

believe additional flexibility is not required and/or meaningful. As such, we recommend the FRTIB not add a nonU.S. bond fund as an investment fund alternative.
U.S. STOCK 

 Ennis Knupp + Associates 7.1 

Our rationale for reviewing the merits of offering additional broad-based U.S. stock investment funds include: 

 Participants’ knowledge of U.S. stock investing has grown tremendously in recent years – resulting in 

increased demand for U.S. stock fund alternatives. 

 As the allocation to U.S. stocks is generally one of the largest components of a participant’s portfolio, a 

subset of participants desire to customize their defined contribution plan U.S. stock portfolios to account for 

personal (taxable and tax-exempt) investments, complement investment funds available in a spouse’s plan 

and/or account for their own investment preferences/risk tolerance. 

 It represents contemporary practice. 

The types of U.S. stock funds that we generally recommend offering are: 

– Core stock index fund 

– Larger-cap value 

– Larger-cap growth 

– Mid-/small-cap stock 

Depending upon a plan’s circumstances, four to eight U.S. stock funds are typically offered to participants. The 

number of options offered is generally influenced by the number of active and passive funds offered and how 

finely each of the categories is defined. 

The TSP plan already offers access to large cap stocks and mid/small cap stocks via the C and S Funds, 

respectively. In this section of the report, we focus our attention on large cap value and growth options. 
U.S. STOCK 

 Ennis Knupp + Associates 7.2 

Current Stock Funds Composition 

Below we show the sector composition of the U.S. stock funds (C and S Funds) currently offered to participants 

according to the Funds’ benchmarks, the S&P 500 and Dow Jones Wilshire 4500, respectively. The current C 

and S Funds benchmarks are well diversified by sector. 

S&P 500 Index - Sector Breakdown

Consumer Staples 10%

Energy 9%

Financials 22%

Health Care 13%

Industrials 11%

Information Technology

15%

Materials 3%

Telecom Service 4% Consumer 

Discretionary 10%

Utilities 3%

DJ Wilshire 4500 Index - Sector Breakdown

Consumer NonDurables 17%

Energy 7%

Financials 25%

Materials & Services

22%

Technology 13%

Transportation 2%

Utilities 6%

Capital Goods 5%

Consumer Durables

3%
U.S. STOCK 

 Ennis Knupp + Associates 7.3 

Growth stocks are generally thought of as those that have a high earnings growth rate, high price-to-book and 

high price-to-earnings ratios. Value stocks on the other hand are thought of as those that have a high dividend 

yield, low price-to-book and low price-to-earnings ratios. 

We show the historical returns, volatility (annualized standard deviation) and Sharpe Ratios for the Russell 1000 

Growth and Value Indexes. We have used the Russell family of U.S. stock indexes as these are the most 

popularly followed style indexes. Russell utilizes two major factors in determining whether a stock is a value 

stock or a growth stock – book-to-price ratio, and the long-term growth rate mean obtained from analysts’ 

estimates. Lower book-to-price ratios would denote growth characteristics. 

 

Annualized Returns (As of June 30, 2006) 

Trailing Years

Russell 1000 Growth 

Index Russell 1000 Value Index S&P 500 Index 

1 6.1% 12.1% 8.6% 

3 8.4 15.7 11.2 

5 -0.8 6.9 2.5 

10 5.4 10.8 8.3 

15 8.7 12.7 10.7 

20 9.4 12.1 11.0 

27 Years 6 Months 

(Since inception) 11.7 14.3 13.2 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Years 

Russell 1000 Growth 

Index Russell 1000 Value Index S&P 500 Index 

5 15.0% 13.1% 13.6% 

10 19.6 14.5 15.7 

15 17.1 12.9 13.9 

20 18.0 14.2 15.2 

27 Years 6 Months 

(Since inception) 17.7 14.0 15.0 

Sharpe Ratio (As of June 30, 2006) 

Trailing Years 

Russell 1000 Growth 

Index Russell 1000 Value Index S&P 500 Index 

5 -0.10 0.44 0.12 

10 0.20 0.56 0.38 

15 0.37 0.73 0.56 

20 0.36 0.59 0.50 

27 Years 6 Months 

(Since inception) 0.40 0.63 0.53 
U.S. STOCK 

 Ennis Knupp + Associates 7.4 

We show the correlations of the various capitalization and valuation segments in the following table. 

Correlations (18 years ending December 31, 2005) 

C Fund S Fund I Fund F Fund G Fund 

Russell 

1000 

Growth 

Russell 

1000 

Value 

C Fund 1.00 

S Fund 0.80 1.00 

I Fund 0.62 0.56 1.00 

F Fund 0.18 0.09 0.08 1.00 

G Fund 0.01 0.05 0.09 0.14 1.00 

Russell 1000 Growth 0.95 0.85 0.58 0.14 0.01 1.00 

Russell 1000 Value 0.91 0.68 0.56 0.20 0.02 0.75 1.00 

Observations 

The historical data suggests that adding a value-oriented investment fund would be appropriate as the value 

index has performed well relative to its core and growth index counterparts from a return and risk perspective. 

The value index also has lower correlations and higher Sharpe Ratios to the current U.S. stock funds than the 

growth index. 

While the data indicates value-oriented stocks are appealing to offer as an investment fund alternative relative to 

growth-oriented stocks, performance figures present a particularly compelling case as a result of their significant 

outperformance relative to growth stocks over the past six years. However, if this analysis ended on June 30, 

2000, it would have led to a different conclusion as growth stocks had materially outperformed value at that point 

in time and points to “return end-point dependency”. 

The common practice in the marketplace for plans that offer style specific funds is to offer both value and growth 

funds so complementary styles are offered to participants and they have the flexibility to customize their 

portfolios. 

Index Investment Options 

The table below shows the amount of assets indexed to large-cap value and growth style equities by the major 

institutional index fund managers. 

U.S. Equity Styles Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

Russell 1000 Growth Index $6,704 $5,631 $4,471 

Russell 1000 Value Index 11,121 5,185 6,758 
U.S. STOCK 

 Ennis Knupp + Associates 7.5 

U.S. Equity Styles Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA 

Russell 1000 Growth Index $709 $1,802 $256 

Russell 1000 Value Index 1,172 1,659 951 

The level of assets currently invested in index funds benchmarked to the Russell 1000 Value Index is material at 

over $23 billion at BGI, NTGI and SSgA. While a lesser amount, the assets indexed to the Russell 1000 Growth 

Index are also substantial at over $16 billion. 

Considerations 

It is generally common practice for peer plans to offer growth- and value-oriented U.S. stock funds, with it being 

more common to offer larger-capitalization growth and value funds than smaller-capitalization growth and value 

funds. Larger-capitalization growth and value funds are attractive alternatives from a market size, liquidity, sector 

and security diversification, and contemporary practice standpoint. The diversification benefits, however, would 

not be material relative to the current investment funds already available. We do not believe it is necessary for 

the TSP to offer any additional U.S. stock funds as the C and S Funds provide exposure to the entire U.S. stock 

market. Offering a more limited number of U.S. stock funds without foregoing material improvement in portfolios 

would be consistent with avoiding investment choice overload. 

 

Conclusion 

On balance, we do not find a compelling reason to add additional U.S. stock funds, as the TSP’s current 

investment line-up provides broad exposure to the U.S. stock market via the C and S Funds. 
U.S. STOCK 

 Ennis Knupp + Associates 7.6 

(This page left blank intentionally) 
EMERGING MARKETS 

 Ennis Knupp + Associates 8.1 

We review the merits of offering an emerging markets stock fund as an investment alternative for the following 

reasons: 

 Large market with total capitalization of $2.0 trillion 

 Emerging markets are diversified by country, sector, industry and securities 

 TSP participants do not currently have exposure to emerging markets 

 Daily valued index products are available 

 Expectations that emerging markets will provide exposure to some of the world’s most rapidly expanding 

economies 

While “emerging markets” are a commonly used term in today’s investment world, there isn’t a single concise 

definition for what constitutes an emerging market economy. In general, countries with developing economies 

that have low- to mid-per capita income levels and are experiencing positive structural changes to the 

characteristics of their economic systems can be thought of as emerging market economies. These changes 

include, but are not limited to, deregulation and privatization of industry, rationalization of monetary and fiscal 

policies, elimination of trade barriers, enhancement of property rights, etc. In other words, these economies can 

be thought of as transitional economies – ones that aren’t yet perfectly integrated into the global financial 

system, but making strides to get there. 

On the following pages we review the composition of the emerging markets stock index, its historical 

performance and the potential diversification benefits of adding an emerging markets stock fund. 

We use the Morgan Stanley Capital International (MSCI) Emerging Markets (EM) Stock Index, the most widely 

followed emerging markets stock index, to review the characteristics and performance of emerging markets 

stocks. The following exhibits show that emerging markets are diversified by sector and country. 
EMERGING MARKETS 

 Ennis Knupp + Associates 8.2 

The chart below shows the sector composition of the MSCI Emerging Markets Stock Index. 

Emerging Market Characteristics (As of September 30, 2006) 

Market Capitalization ($ in millions) $2.0 trillion 

Number of Securities 852 

Average market capitalization $2.3 billion 

Emerging Markets - Sector Breakdown

Energy 17.5%

Consumer 

Discretionary 6.5%

Consumer Staples

5.4%

Financials 19.2%

Health Care 2.1%

Industrials 7.7%

Information Technology

15.2%

Materials 12.4%

Telecommunications

Services 10.7%

Utilities 3.4%
EMERGING MARKETS 

 Ennis Knupp + Associates 8.3 

The countries that comprise the MSCI Emerging Markets Stock Index are shown in the table below. 

Emerging Market Country Allocation (As of September 30, 2006) 

Country/Region % Allocation 

 

China 9.5% 

India 6.7 

Indonesia 1.6 

Korea 17.5 

Pakistan 0.2 

Philippines 0.5 

Malaysia 2.6 

Taiwan 13.0 

Thailand 1.6 

Asia 53.4% 

 

Czech Republic 0.8% 

Egypt 0.9 

Hungary 1.0 

Israel 2.7 

Jordan 0.2 

Morocco 0.3 

Poland 1.6 

Russia 10.7 

Turkey 1.5 

Europe & Middle East 19.7% 

 

Argentina 0.7% 

Brazil 10.0 

Chile 1.5 

Colombia 0.3 

Mexico 6.1 

Peru 0.5 

Venezuela 0.1 

Latin America 19.3% 

 

South Africa 7.7% 

Africa 7.7% 

TOTAL 100.0% 
EMERGING MARKETS 

 Ennis Knupp + Associates 8.4 

Historical Performance 

In the following chart, we show the annual returns of emerging markets over time. As seen in the chart, emerging 

market investments exhibit a very high degree of variability (volatility) from year to year. 

We show the annualized returns, volatility and Sharpe Ratios for the MSCI Emerging Markets Stock Index in the 

following tables. 

Annualized Returns (As of June 30, 2006) 

Trailing Years MSCI Emerging Markets Index

1 35.5% 

3 34.3 

5 21.2 

10 6.4 

15 9.8 

18 Years 6 Months (since inception) 14.0 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Years MSCI Emerging Markets Index 

5 20.5% 

10 24.3 

15 22.3 

18 Years 6 Months (since inception) 23.0 

Emerging Markets - Annual Returns

-40%

-20%

0%

20%

40%

60%

80%

1988 1990 1992 1994 1996 1998 2000 2002 2004

Year

Return (%)
EMERGING MARKETS 

 Ennis Knupp + Associates 8.5 

Sharpe Ratio (As of June 30, 2006) 

Trailing Years MSCI Emerging Markets Index 

5 0.96 

10 0.24 

15 0.38 

18 Years 6 Months 0.51 

The table below shows the historical correlations of the MSCI Emerging Markets Stock Index relative to the 

current TSP Funds. 

Correlations (18 years ending December 31, 2005) 

 C Fund S Fund I Fund F Fund G Fund 

MSCI EM 

Index 

C Fund 1.00 

S Fund 0.80 1.00 

I Fund 0.62 0.56 1.00 

F Fund 0.18 0.09 0.08 1.00 

G Fund 0.01 0.05 0.09 0.14 1.00 

MSCI EM Index 0.59 0.64 0.57 -0.04 0.07 1.00 

Emerging market returns are modestly correlated to the C, S and I Fund and uncorrelated to the F and G Funds.

Below we show the efficient frontiers, based on historical data, using the TSP Funds with and without emerging 

markets as an investment fund alternative. 

Efficient Frontier (Based on Historical Data)

Current Options (with Emerging Markets; Jan 1988 - Dec 2005)

S Fund

I Fund

F Fund

T-Bills

C Fund

Emerging Markets

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

0.0 5.0 10.0 15.0 20.0 25.0 30.0

Risk (%)

Return (%)

Current Options Current Options (with Emerging Markets)

G Fund
EMERGING MARKETS 

 Ennis Knupp + Associates 8.6 

As shown, the efficient frontier with emerging markets as an investment fund alternative changes only modestly 

at low to fairly high risk levels (1% to 15% risk or annualized standard deviation of return), providing a slight 

improvement in the risk/return profile. At the highest risk levels, the benefit is more pronounced (risk from 15% to 

25%). We believe the improvement in the efficient frontier would be of little benefit to the majority of TSP 

participants as most would not likely construct highly risky portfolios. 

The tables below show the amount of assets indexed to emerging market equities by the major institutional index 

fund mangers. 

Emerging Markets Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

MSCI Emerging Markets Index $2,596 $130 $4,194 

Emerging Markets Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA 

MSCI Emerging Markets Index -- -- $181 

The total assets indexed to emerging market stocks amongst the leading index fund providers is approximately 

$7.0 billion. 

 

Considerations 

Emerging markets have received much attention recently as performance has been very strong, and the world’s 

developing economies are expected to experience strong secular growth. These strong expectations, however, 

come with considerable risk in terms of volatility of returns and political risk that is not typically present in the 

developed markets. Emerging markets have seen materially negative results over certain periods, more 

frequently than in their developed markets counterparts. This causes us to pause when considering such an 

option for a defined contribution plan, where a participant could potentially put all their assets in a single fund. 

Emerging market funds are not commonly found in peer plans as stand alone investment options. 

Conclusion 

While emerging markets are a large asset class, expected to experience secular growth, and provide a benefit to 

portfolios at the highest levels of risk, we have concerns with the TSP offering emerging markets as a stand 

alone investment fund. The high risk associated with emerging markets has resulted in material losses over 

relatively short periods of time and is difficult for participants (or for any investor) to bear. Additionally, there are 

limited benefits to adding emerging market equities to well-diversified low to moderate risk portfolios. 

Overall, we believe the negatives of offering an emerging markets investment fund outweigh the positives and 

recommend an emerging market stock fund not be added as an investment fund alternative. Moreover, we 

believe it is appropriate to monitor the possibility of accessing the emerging markets via the I Fund in the future, 

as index fund managers may offer a daily valued index fund that provides exposure to both the developed nonU.S. stock markets and emerging markets in their respective market capitalization proportions. 
TIPS 

 Ennis Knupp + Associates 9.1 

We evaluate Treasury-Inflation Protected Securities (TIPS) as a potential investment fund alternative. Our 

rationale for recommending an in-depth review of TIPS was based on: 

 Large and growing market: while the market capitalization of TIPS is less than $1 trillion, the market has 

grown substantially in recent years (from $0 in 1997 to $370 billion today) 

 Participants do not have exposure to TIPS currently 

 Inflation-linked coupon payments and principal associated with TIPS are attractive characteristics to many 

investors 

 TIPS offer modest portfolio diversification benefits 

 While TIPS are not diversified by issuer, their creditworthiness is backed by the full faith and credit of the 

U.S. government 

 Daily valued index products are available from major index providers 

TIPS are similar to securities issued by the U.S. Treasury such as notes and bonds, but offer protection from 

inflation. Similar to other instruments issued by the U.S. Treasury, TIPS pay coupon interest on a semi-annual 

basis and principal on maturity. 

The principal value of TIPS is linked to inflation, as measured by the Consumer Price Index (CPI), and 

accordingly the principal value changes through time – referred to as “adjusted principal”. Increasing inflation 

results in an increase in the principal value of the TIPS. At maturity, the Treasury pays the original principal or 

the adjusted principal, whichever is greater. The coupon interest, which is paid on a semi-annual basis, is based 

on a fixed rate on the adjusted principal value. 
TIPS 

 Ennis Knupp + Associates 9.2 

Historical Performance 

We show the historical performance of Lehman Brothers TIPS Index relative to the Lehman Brothers Aggregate 

Bond Index, the benchmark for the F Fund, in the tables below. 

Annualized Returns (As of June 30, 2006) 

Trailing Years LB TIPS Index LB Aggregate Bond Index

1 -1.6% 0.8% 

3 3.8 2.1 

5 7.0 5.0 

9 Years 4 months (since inception) 6.7 6.0 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Year LB TIPS Index LB Aggregate Bond Index

5 6.4% 4.0% 

9 Years 4 months (since inception) 5.0 3.5 

Sharpe Ratios (As of June 30, 2006) 

Trailing Year LB TIPS Index LB Aggregate Bond Index

5 0.81 0.78 

9 Years 4 months (since inception) 0.70 0.76 

The Sharpe ratios of TIPS and the Lehman Brothers Aggregate Bond Index are similar over the longest common 

time period. 

The table below shows the historical correlations of the Lehman Brothers TIPs Index relative to the current TSP 

Funds.

Correlations (8 years 10 months ending December 31, 2005) 

 C Fund S Fund I Fund F Fund G Fund 

LB TIPS 

Index 

C Fund 1.00 

S Fund 0.79 1.00 

I Fund 0.81 0.75 1.00 

F Fund -0.11 -0.09 -0.13 1.00 

G Fund -0.01 0.06 0.10 0.15 1.00 

LB TIPS Index -0.17 -0.14 -0.14 0.77 0.22 1.00 

As shown, TIPS returns are negatively correlated to those of the C, S and I Fund, but highly correlated to those 

of the F Fund. The correlation of returns between TIPS and the G Fund is low as well. 
TIPS 

 Ennis Knupp + Associates 9.3 

The tables below show the amount of assets indexed to TIPS by the major institutional index fund managers. 

TIPS Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

Lehman Brothers TIPS Index $2,186 $1,397 $5,054 

TIPS Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA 

Lehman Brothers TIPS Index $120 $447 $1,271 

The amount of assets indexed to TIPS among the major index fund providers is approximately $9 billion. 

Considerations 

As discussed earlier in the report, we generally advocate that our clients offer only one option in the diversified 

fixed income/bond fund category, but believe it was worthwhile to review TIPS given that they provide inflation 

protection. We advocate simplicity in the bond category as participants generally do not allocate significant 

assets to bond funds, and generally do not attain material benefits from specialized bond funds if they have a 

broadly diversified portfolio. Additionally, it is difficult to educate participants regarding the drivers of a 

specialized bond fund’s performance (interest rate sensitivity, credit risk, etc). 

Importantly, TSP participants are offered inflation protection via the G Fund. As yields of nominal U.S. Treasury 

securities generally reflect expected inflation plus a real return component, if inflation increases or is expected to 

increase, the yields of Treasuries are expected to increase; and the G Fund’s yield should increase as well. The 

benefit TSP participants have is that the principal value of their G Fund investments does not decline – as a 

result they do not experience any price volatility. Investors who purchase nominal bonds or TIPS do incur price 

volatility, which makes the G Fund much more attractive. The characteristics of the G Fund provide a powerful 

diversification benefit and negate much of the benefits a TIPS fund could provide to TSP participants. 

Another issue with offering a TIPS fund is that the fund is a blend of TIPS securities with different maturities and 

the effective maturity of the portfolio may not match the period that the participant seeks to hedge their inflation 

risk (e.g., 20 years). A buy and hold strategy of individual TIPS securities may better meet their objective. A 

participant would generally benefit from investing in a TIPS Fund, but it may not be their ideal solution. 

The U.S. Treasury auctions TIPS in three maturities – 5-years, 10-years and 20-years. TIPS are a good hedge 

against inflation if they are held until maturity – since the coupon payments over the life of the TIPS are based on 

inflation-adjusted principal, and at maturity the investor receives the higher of the inflation adjusted principal or 

the original principal. Over shorter periods, however, TIPS may not yield a return comparable with inflation since 

the prices at which the bonds may be traded (bought and sold) may not be perfectly in sync with inflation over a 

given holding period.
TIPS 

 Ennis Knupp + Associates 9.4 

Conclusion 

While TIPS are attractive to investors who want to hedge inflation, the TSP offers a fund (G Fund) that provides 

similar characteristics over the long-term without negative price volatility, which negates the benefits of offering a 

TIPS fund. Additionally, a TIPS Fund would provide limited diversification benefits to TSP participants, add 

complexity to an investment category where we believe additional flexibility is not required, and is not common 

practice among peer plans. Therefore, we recommend the FRTIB not offer TIPS as an investment fund 

alternative. 
REITs 

 Ennis Knupp + Associates 10.1 

We review the merits of offering a REIT index fund as an investment alternative for the following reasons: 

 Low correlation of returns relative to major market indexes 

 REITs have grown substantially in market capitalization in recent years 

 The major index fund managers offer REIT index funds 

 REITs have garnered much attention over the last several years 

Real Estate Investment Trusts, or REITs are specialized companies that own, and in most cases operate income 

generating real estate properties. REITs are listed on most major stock markets and can be traded just like 

shares in any other company. REITs allow smaller investors the ability to share in the ownership of large, income 

generating real estate such as apartments, offices, hotels, and shopping centers – essentially allowing smaller 

investors the ability to diversify their exposure to real estate investments through investing in a portfolio of 

properties rather than an investment in a single or few properties. REITs must distribute at least 90% of their 

taxable income to shareholders annually. 

As REITs are publicly traded securities and listed on U.S. stock exchanges, REITs are included in the major U.S. 

stock market indexes as part of the finance sector, and as such, we consider REITs a sub-sector, similar to 

autos within consumer durables, pharmaceuticals within healthcare, or insurance within the finance sector. We 

show the composition of the broad U.S. stock market, as defined by the Dow Jones Wilshire 5000 Stock Index, 

the S&P 500 (C Fund) and Dow Jones Wilshire 4500 Stock Index (S Fund) below. 
REITs 

 Ennis Knupp + Associates 10.2 

Sector Breakdown of Wilshire 5000 Index

Capital Goods

5.7%

Consumer Durables

1.7%

Consumer Non-Durables

25.5%

Energy

8.9%

Materials & Services

9.9%

Technology

17.2%

Transportation

1.7%

Utilities

6.7% REITs

2.5%

Other

20.2%

Finance

22.8%

Sector Breakdown of S&P 500 Index

Consumer Staples

9.6%

Energy

9.3%

Health Care

12.7%

Industrials

10.9% REITs

1.0%

Utilities

Consumer 3.4%

Discretionary

10.1%

Information Technology

15.3%

Materials

2.9% Telecom Service

3.5%

Finance

22.3%

Other

21.3%
REITs 

 Ennis Knupp + Associates 10.3 

Sector Breakdown of Wilshire 4500 Index

Capital Goods

4.5%

Consumer Durables

2.9%

Consumer Non-Durables

16.7%

Energy

7.3%

Materials & Services

22.1%

Technology

12.8%

Transportation

2.4%

Utilities

5.8%

REITs

7.5%

Other

17.8%

Finance

25.3%
REITs 

 Ennis Knupp + Associates 10.4 

The table below shows the composition of the DJ Wilshire Equity REIT Index. REITs are diversified among many 

different types of real estate properties. 

DJ Wilshire Equity REIT Index – Sector Breakdown

Sector % Allocation 

Retail 27.1% 

Multifamily 20.3 

Office 19.7 

Diversified 11.7 

Leisure 7.9 

Industrial 7.5 

Healthcare 0.0 

Self Storage 5.4 

Other 0.4 

Historical Performance 

We show the historical returns, volatility and Sharpe Ratios for three popular REIT Indexes below. 

Annualized Returns (As of June 30, 2006) 

Trailing Years

DJ Wilshire 

Equity REIT 

Index MSCI REIT Index

FTSE NAREIT 

Index

1 22.0% 19.6% 19.1% 

3 27.7 26.2 26.1 

5 20.2 19.4 19.4 

10 16.2 15.1 15.1 

11 years 6 months (MSCI inception) 15.7 14.8 15.1 

15 14.3 -- 14.7 

20 11.0 -- 12.1 

28 years 6 months (DJ Wilshire inception) 14.7 -- 14.9 

34 years 6 months (FTSE NAREIT inception) -- -- 13.6 
REITs 

 Ennis Knupp + Associates 10.5 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Years 

DJ Wilshire 

Equity REIT 

Index MSCI REIT Index 

FTSE NAREIT 

Index 

5 15.1% 14.8% 14.6% 

10 14.6 14.4 14.0 

11 years 6 months (MSCI inception) 13.9 13.7 13.2 

15 13.4 -- 12.9 

20 13.6 -- 12.9 

28 years 6 months (DJ Wilshire inception) 14.8 -- 13.2 

34 years 5 months (FTSE NAREIT inception) - -- 13.8 

Sharpe Ratios (As of June 30, 2006) 

Trailing Years 

DJ Wilshire 

Equity REIT 

Index MSCI REIT Index 

FTSE NAREIT 

Index 

5 1.18 1.15 1.17 

10 0.88 0.83 0.85 

11 years 6 months (MSCI inception) 0.88 0.83 0.87 

15 0.81 - 0.87 

20 0.53 - 0.63 

28 years 6 months (DJ Wilshire inception) 0.62 - 0.69 

34 years 6 months (FTSE NAREIT inception) - - 0.58 

As shown in the tables above, REITs have performed particularly well over the past five years, with an 

annualized return exceeding 19%. Over the past ten years, REITs have outpaced large-cap, mid-cap and smallcap U.S. stocks by over two percentage points. For the twenty-year period, however, REIT returns are 

comparable to the U.S. stock market and their Sharpe ratios are also similar -- 0.43 for the DJ Wilshire REIT 

Index, 0.50 for the S&P 500 Stock Index and 0.42 for the Dow Jones Wilshire 4500 Stock Index. 
REITs 

 Ennis Knupp + Associates 10.6 

We show the historical correlations of REITs to those of the current TSP investment funds in the table below. 

Correlations (11 years ending December 31, 2005) 

 C Fund S Fund I Fund F Fund G Fund 

MSCI US 

REIT 

Index 

FTSE 

NAREIT 

US REIT 

DJ 

Wilshire 

Equity 

REIT 

Index 

C Fund 1.00 

S Fund 0.78 1.00 

I Fund 0.77 0.72 1.00 

F Fund -0.04 -0.08 -0.12 1.00 

G Fund -0.01 0.04 0.07 0.17 1.00 

MSCI US REIT Index 0.28 0.34 0.29 0.05 0.04 1.00 

FTSE NAREIT Index 0.29 0.35 0.29 0.06 0.06 1.00 1.00 

DJ Wilshire Equity 

REIT Index 0.27 0.33 0.28 0.04 0.04 1.00 0.99 1.00 

As shown in the table above, REITs have had a low correlation of returns to each of the investment funds that 

the TSP currently offers. 

We show the historical efficient frontiers using the current TSP Funds with and without REITs as an investment 

fund alternative. We use the DJ Wilshire REIT Index as a proxy for REITs. The DJ Wilshire REIT Index is more 

investable than the FTSE NAREIT Index, and better represents the opportunity set available to the TSP. Little to 

no assets are passively managed to the FTSE NAREIT Index, largely due to its lower investability. The FTSE 

NAREIT Index is also not widely used to benchmark actively managed REIT portfolios. We use the DJ Wilshire 

REIT Index over the MSCI U.S. REIT Index as it has a much longer return history. 
REITs 

 Ennis Knupp + Associates 10.7 

As shown, there is very little difference in the efficient frontiers with and without REITs as an investment fund 

alternative. REITs provide a diversification benefit due to the low to negative correlation of returns with the 

existing TSP investment options. However, some of the diversification benefit is offset by its lower return and 

relatively higher risk. 

We show the amount of assets indexed to REITs at BGI, NTGI and SSgA. 

REITs Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

MSCI U.S. REIT Index $941 -- -- 

DJ Wilshire REIT Index 518 -- $2,747 

NAREIT U.S. REIT Index -- -- -- 

REITs Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA 

MSCI U.S. REIT Index $941 -- -- 

DJ Wilshire REIT Index -- -- $152 

NAREIT U.S. REIT Index -- -- -- 

Efficient Frontier (Based on Historical Data)

Current Options (with DJ Wilshire REIT; Jan 1988 - Dec 2005)

C Fund

I Fund

F Fund

G Fund

T-Bills

DJ Wilshire REIT

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0 5.0 10.0 15.0 20.0 25.0

Risk (%)

Return (%)

Current Options Current Options (with DJ Wilshire RESI)
REITs 

 Ennis Knupp + Associates 10.8 

The three leading institutional index fund providers listed above have in aggregate approximately $4 billion in 

assets indexed to the REIT indices. The total assets (including mutual funds) indexed to REITs have increased 

significantly in recent years to over $10 billion. 

Considerations 

REITs have gained in popularity in recent periods due to their strong performance, low correlation of returns to 

many of the major capital markets, improved liquidity, and overall growth of the REIT market. This has caused 

many investors to review whether or not they should have an explicit exposure to REITs. While TSP participants 

invest in REITs through their investments in the C and S Funds, a REIT option would allow participants to make 

a specific above-market allocation to the sector. The number of defined contribution plans offering a REIT option 

has increased over the years. 

While the returns and low correlations are attractive, REITs are a sub-sector of the U.S. stock market and the 

current market capitalization of REITs is materially below those of the capital markets currently offered to 

participants – approximately $380 billion for REITs versus trillions of dollars for the indexes currently tracked. 

The extraordinary asset size of the TSP could cause it to become a disproportionately large investor and trader 

of REITs if only 5% or 10% of plan assets were allocated to REITs. While liquidity in the REITs market has 

improved significantly, accommodating cash flows in excess of $200 million on some days (a distinct possibility 

based on the TSP’s experience with the I Fund), may be challenging, which could negatively impact participants. 

Moreover, while REITs have low correlations with TSP’s current investment options, its addition to the portfolio 

mix does not result in any material improvement in the efficient frontier. While the number of plans offering a 

REIT option has increased, only 1 in every 6 plans offers such an option even today, and where offered, 

utilization rates tend to be low. 

Conclusion 

REITs are a sub-sector of the U.S. stock market with a market capitalization of less than $400 billion. TSP 

participants currently can attain exposure to REITs in market weights via the C and S Funds. The low correlation 

of REIT returns to major capital markets has the potential of providing a diversification benefit, but the benefit of 

offering REITs does not significantly improve TSP participant portfolios. It is also not common practice among 

peers to offer a stand alone REIT option. Overall, we believe the negatives more than outweigh the potential 

benefit of REITs. We recommend the FRTIB not offer REITs as an investment fund alternative.
COMMODITIES 

 Ennis Knupp + Associates 11.1 

Over the last few years, investing in commodities has caught the attention of institutional investors. Steep 

declines in equity markets from 2000 to 2002 coupled with strong returns from commodities have contributed to 

this phenomenon. 

Commodities include energy (crude oil, natural gas, etc.), precious metals (gold, silver, etc.), base metals 

(copper, aluminum, etc.), and agricultural products (pork bellies, soybeans, etc.). Commodities provide a strong 

diversification benefit, as they tend to have low or even negative correlations with other asset classes. Investing 

in commodities is typically achieved using futures contracts, as investing in physical commodities is generally not 

feasible; most investors don’t have the ability to buy and store crude oil or grains. 

Futures contracts can be bought by placing a margin deposit with the futures broker. The margin is typically a 

small fraction of the value of the futures contract and is adjusted (marked-to-market) on a daily basis depending 

on the change in the value of the contract. In order to gain exposure to the underlying commodity / financial 

instrument, the investor need only place a fraction of the value of the exposure desired in the margin account, 

implying that purchasing futures contracts on margin essentially results in the use of leverage. In order to 

maintain an un-levered exposure to the underlying commodity, an investor can buy the necessary futures 

contract on margin and place the remaining investments in cash or a cash-like instrument. 

As a result, the returns from a long-only un-levered investment in futures contracts can be decomposed as 

follows: 

Spot Return – Return attributable to the change in the price level of the underlying commodity represented by 

the futures contract 

Roll Return – Return associated with “rolling” the futures contract at each contract maturity date. Futures 

contracts have a finite life. In order to maintain continuous exposure to the underlying assets, investors need to 

sell near-dated futures contracts at expiration and buy longer-dated contracts. The process of trading the futures 

to maintain exposure to the underlying commodity is referred to as rolling the futures. The roll process can result 

in either a profit or a loss. 

Collateral Return – The yield on the cash instrument held as collateral against the futures investment. 
COMMODITIES 

 Ennis Knupp + Associates 11.2 

The chart below shows the sector breakdown of the Goldman Sachs Commodities Index (GSCI), which is the 

most widely tracked commodities index. 

Historical Performance 

We show the historical performance of the Goldman Sachs Commodities Index, the more widely tracked 

commodity index, below. 

Annualized Returns (As of June 30, 2006) 

Trailing Years GSCI

1 13.4% 

3 20.2 

5 14.6 

10 8.1 

15 7.6 

20 11.6 

36 Years and 6 Months (since inception) 12.3 

GSCI Sector Composition

Energy 70%

Industrial Metals 11%

Precious Metals 2%

Agriculture 12%

Livestock 5%
COMMODITIES 

 Ennis Knupp + Associates 11.3 

Annualized Standard Deviation (As of June 30, 2006) 

Trailing Years GSCI

5 22.3% 

10 21.6 

15 18.8 

20 18.6 

36 Years and 6 Months (since inception) 18.7 

Sharpe Ratios (As of June 30, 2006) 

Trailing Years GSCI

5 0.64 

10 0.32 

15 0.30 

20 0.46 

36 Years and 6 Months (since inception) 0.41 

The Sharpe ratios for commodities over the 20-year period are comparable to the S&P 500 (0.50) and Dow 

Jones Wilshire 4500 (0.42), higher than the MSCI EAFE Index (0.31) and lower than the Lehman Aggregate 

Bond Index (0.76). 
COMMODITIES 

 Ennis Knupp + Associates 11.4 

Correlations (18 years ending December 31, 2005) 

 C Fund S Fund I Fund F Fund G Fund GSCI 

C Fund 1.00 

S Fund 0.80 1.00 

I Fund 0.62 0.56 1.00 

F Fund 0.18 0.09 0.08 1.00 

G Fund 0.01 0.05 0.09 0.14 1.00 

GSCI -0.09 0.02 0.00 -0.03 0.04 1.00 

As shown in the table above, commodities have had very low correlation of returns relative to the TSP’s current 

investment funds. 

Below we show the amount of assets indexed to commodities with the leading index fund providers. 

Commodities Index Fund Products (assets in millions) – All assets 

BGI NTGI SSgA 

GSCI $166 - $437 

DJ AIG - - $447 

Commodities Index Fund Products (assets in millions) – Daily-valued DC assets 

BGI NTGI SSgA 

GSCI - - - 

DJ AIG - - - 
COMMODITIES 

 Ennis Knupp + Associates 11.5 

Below we show the efficient frontier using the TSP Funds without and with commodities as an investment 

alternative. We show the efficient frontiers using historical data. 

As shown, the efficient frontier with commodities as an investment fund alternative is superior to the efficient 

frontier with only the current TSP investment funds. 

Considerations 

Commodities futures offer a significant diversification benefit, and a potential hedge against inflation. They have 

also achieved strong returns in the past, comparable to U.S. equities. We note that spot commodities have 

actually underperformed both cash and inflation over the long term; commodity futures have outperformed 

because of the roll return and collateral yield. Unlike other capital assets such as equities or fixed income 

securities, commodities do not represent the capitalization of a stream of future cash flows. Commodity prices 

and consequently returns, are driven by current and expected supply/demand; we have no means to expect the 

roll returns of the past to continue in the future. In addition, the Goldman Sachs Commodities Index (GSCI), the 

most widely tracked commodities index, has a substantial allocation (70%) to the energy sector. As compared to 

other investment options offered in the TSP, which are well diversified investments, an allocation to commodities 

results in a significant concentration to one sector of the market. While there are other commodity indexes that 

are better diversified within the different commodity sectors as compared to the GSCI, the allocations between 

the sectors are constrained on an arbitrary basis. 

Participants’ general knowledge of the intricacies of the working of commodity futures is likely to be minimal, 

which could result in inappropriate allocations to such an investment fund in the program. We also note that it is 

not a commonly offered investment option in defined contribution programs. 

Efficient Frontier (Based on Historical Data)

Current Options (with Commodities; Jan 1988 - Dec 2005)

I Fund

F Fund

G Fund

T-Bills

Commodities

C Fund

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0 5.0 10.0 15.0 20.0 25.0

Risk (%)

Return (%)

Current Options Current Options (with Commodities)

S Fund
COMMODITIES 

 Ennis Knupp + Associates 11.6 

Conclusion 

Commodity futures offer a diversification benefit, as well as the potential to hedge against inflation. However, 

commodity prices are influenced by demand/supply considerations rather than the intrinsic value of a security, 

and future return expectations are uncertain. Most individual investors will have difficulty in determining an 

appropriate allocation to commodities, and commodities have a concentration in the energy sector. Commodity 

funds are also not a common investment option in defined contribution plans. We recommend that the FRTIB not

offer commodities as an investment option in the TSP. 
RECOMMENDATIONS 

 Ennis Knupp + Associates 12.1 

In the previous sections of this report we: 

 Reviewed the current circumstances of the TSP and compared its practices to peer plans 

 Identified key criteria for evaluating investment fund alternatives 

 Applied the key criteria to a broad array of investment fund alternatives to identify investment funds 

appropriate for an in-depth review 

 Reviewed the appropriateness of six asset classes/categories in-depth as potential investment fund 

alternatives 

The key points of our report and our recommendations are summarized below 

Current Practices and Comparison to Peers

 TSP participants are offered the type of investment funds predominantly used by participants in peer plans. 

Importantly, participants are offered five core investment options that span the risk/return spectrum and are 

offered the option of selecting pre-mixed portfolios (L Funds) that reflect different risk/return characteristics 

and embrace the key principles of investing – diversification among and within asset classes, low cost, 

rebalancing to maintain target portfolio weights, and target weights that evolve as an investor’s time horizon 

shortens. 

 

 Our review of the program leads us to the conclusion that the core of the investment program is well 

structured and there are no gaps in the investment line-up. 

Investment Structure

The investment fund types offered to TSP participants match those we believe that the TSP should be offering. 

 U.S. stock 

 Non-U.S. stock 

 Diversified fixed income 

 Cash equivalent/stable value 

 Lifecycle 

Our recommendations regarding the TSP’s investment structure are influenced by our beliefs that: 

 Employee education is one of the most important components of a successful defined contribution plan 

 The number of options should not overwhelm participants 

 The more broadly diversified an asset class/asset category, the better it will serve participants over the longterm 

 Participants should be provided with two decision-making paths – an array of lifecycle funds and an array of 

broadly diversified asset class/category funds 
RECOMMENDATIONS 

 Ennis Knupp + Associates 12.2 

Key Evaluation Criteria For Investment Fund Alternatives 

In evaluating the types of investment fund alternatives to offer in the TSP, we believe the following criteria 

(individually and collectively) are the most relevant to consider: 

 Major diversified asset class/category not currently offered as an investment option 

 Asset class/category is large enough for the TSP to invest in 

 Potential diversification benefit for TSP participant portfolios 

 Index fund products are available 

 Practices of peers

Application of Key Criteria

In applying the key criteria, we eliminated the following asset classes/categories from further consideration: 

 Non-U.S. small-cap stock 

 High yield bonds 

 Private market real estate 

 Private equity 

 Hedge funds 

 Socially responsible/corporate governance funds 

We then reviewed the merits of offering the following investment fund alternatives in detail: 

 Non-U.S. bonds 

 U.S. stock funds by valuation 

 Emerging markets stock 

 Treasury Inflation-Protected Securities (TIPS) 

 Real Estate Investment Trusts (REITs) 

 Commodities 
RECOMMENDATIONS 

 Ennis Knupp + Associates 12.3 

Recommendations

After reviewing the six asset classes/categories in detail and taking the TSP’s circumstances into account, we 

did not find any of the six compelling as investment fund additions. We recommend the FRTIB not add any 

additional investment funds to its investment program. 

Value and Growth U.S. Stock Funds 

We examined the potential addition of larger-capitalization growth and value stock funds, but did not find this a 

compelling alternative as TSP participants have significant exposure to those segments already; the TSP’s 

investment line-up currently provides broad exposure to the entire U.S. stock market via the C and S Funds. 

If the FRTIB desired to offer additional options from a flexibility standpoint, we believe offering largercapitalization growth and value funds would be the logical first additions as it is common practice, the asset 

categories are large, liquid, diversified. and a material level of assets are indexed to these type of investment 

products. 

Non-U.S. Bonds 

While non-U.S. bonds are a material portion of the world’s investable market capitalization, the benefits of 

adding a non-U.S. bond fund are minimal from an expected risk-return and portfolio diversification standpoint for 

TSP participants. Moreover, adding a non-U.S. bond fund would add complexity to a segment of the plan where 

we believe additional flexibility is not required and/or meaningful. 

Emerging Markets 

Emerging markets are appealing in that the asset class provides diversification at the highest risk levels and TSP 

participants do not have an explicit exposure to the asset class currently. The drawback of emerging markets is 

the high risk historically associated with the asset class, and therefore it is not appropriate to offer as a stand 

alone investment alternative. 

TIPS 

TIPS are an appealing asset class as the inflation protection attributes are commonly sought by investors, and 

TSP participants do not currently have exposure to the asset class. TSP participants, however, are well served 

by the G Fund as an investment fund alternative that assists in hedging the risk of inflation and as such, the 

benefits of offering a TIPS funds are offset. 

REITS 

REITs have received much attention as a result of their strong recent performance and low correlation of returns 

relative to other assets classes. While these are attractive attributes, we do not believe these positive attributes 

outweigh the potential issues with offering a sub-sector of the U.S. stock market as an investment fund 

alternative. REITs are a relatively small asset category when compared to the asset classes/categories that are 

currently offered to TSP participants and the potential diversification benefits are modest. The TSP could also 

face the issue of becoming a disproportionately large owner and trader of REITs if participants allocated a 

moderate amount of the TSP’s total assets to REITs. Additionally, REITs are not a common investment fund 

alternative in peer plans. 
RECOMMENDATIONS 

 Ennis Knupp + Associates 12.4 

Commodities 

Commodities have also received a great deal of attention recently from investors as a result of their strong 

performance and potential diversification benefit. Commodities, however, are a complex asset class as 

investors do not hold the physical commodity and attain exposure via derivative instruments. The way in which 

the asset class is accessed could be difficult to explain to participants and much of the performance and risk 

associated with commodities is attributable to the energy sector, implying participants could be making a bet on 

future energy prices if they were to allocate assets to a commodities investment fund. 
APPENDIX 

 Ennis Knupp + Associates 13.1 

Annual Returns (1970 – 2005) 

Year C Fund S Fund I Fund F Fund G Fund 

MSCI EAFE 

Small Cap 

Index 

1970 4.0% -- -11.7% -- -- -- 

1971 14.3 -- 29.6 -- -- -- 

1972 18.9 -- 36.3 -- -- -- 

1973 -14.8 -- -14.9 -- -- -- 

1974 -26.5 -- -23.2 -- -- -- 

1975 37.2 -- 35.4 -- -- -- 

1976 23.9 -- 2.5 15.6% -- -- 

1977 -7.2 -- 18.1 3.0 -- -- 

1978 6.6 -- 32.6 1.4 -- -- 

1979 18.6 -- 4.8 1.9 -- -- 

1980 32.5 -- 22.6 2.7 -- -- 

1981 -4.9 -- -2.3 6.2 -- -- 

1982 21.5 -- -1.9 32.6 -- -- 

1983 22.6 -- 23.7 8.4 -- -- 

1984 6.3 -1.7 7.4 15.1 -- -- 

1985 31.7 32.0 56.2 22.1 -- -- 

1986 18.7 11.8 69.4 15.3 -- -- 

1987 5.3 -3.5 24.6 2.8 -- -- 

1988 16.6 20.5 28.2 7.9 8.8% -- 

1989 31.7 23.9 10.4 14.5 8.8 -- 

1990 -3.1 -13.6 -23.6 9.0 8.9 -- 

1991 30.5 43.5 12.2 16.0 8.1 -- 

1992 7.6 11.9 -12.2 7.4 7.2 -- 

1993 10.1 14.6 32.7 9.7 6.1 -- 

1994 1.3 -2.7 7.8 -2.9 7.2 -- 

1995 37.6 33.5 11.3 18.5 7.0 -- 

1996 23.0 17.2 6.1 3.6 6.8 -- 

1997 33.4 25.7 1.6 9.7 6.8 -- 

1998 28.6 8.6 20.1 8.7 5.8 -- 

1999 21.0 35.5 26.7 -0.8 6.0 -- 

2000 -9.1 -15.8 -14.2 11.6 6.4 0.4% 

2001 -11.9 -9.3 -21.4 8.4 5.4 -12.5 

2002 -22.1 -17.8 -15.9 10.3 5.0 -7.8 

2003 28.7 43.8 38.6 4.1 4.1 61.3 

2004 10.9 18.1 20.2 4.3 4.3 30.8 

2005 4.9 10.0 13.5 2.4 4.5 26.2 
APPENDIX 

 Ennis Knupp + Associates 13.2 

Annual Returns (1970 – 2005) 

Year 

ML High 

Yield Index 

Citigroup 

WGBI 

Hedged 

Citigroup 

WGBI 

Unhedged 

Russell 

1000 

Growth 

Index 

Russell 

1000 Value 

Index 

MSCI 

Emerging 

Markets 

Index 

1970 -- -- -- -- -- -- 

1971 -- -- -- -- -- -- 

1972 -- -- -- -- -- -- 

1973 -- -- -- -- -- -- 

1974 -- -- -- -- -- -- 

1975 -- -- -- -- -- -- 

1976 -- -- -- -- -- -- 

1977 -- -- -- -- -- -- 

1978 -- -- -- -- -- -- 

1979 -- -- -- 23.9% 20.5% -- 

1980 -- -- -- 39.6 24.4 -- 

1981 -- -- -- -11.3 1.3 -- 

1982 -- -- -- 20.5 20.0 -- 

1983 -- -- -- 16.0 28.3 -- 

1984 -- -- -- -1.0 10.1 -- 

1985 -- 16.3% 27.3% 32.9 31.5 -- 

1986 4.0% 13.6 23.0 15.4 20.0 -- 

1987 4.5 5.7 18.4 5.3 0.5 -- 

1988 13.4 8.2 4.4 11.3 23.2 40.1% 

1989 2.3 8.9 4.3 35.9 25.2 64.6 

1990 -4.4 5.9 12.0 -0.3 -8.1 -10.8 

1991 39.2 13.2 15.8 41.2 24.6 59.4 

1992 17.4 7.9 5.5 5.0 13.8 11.0 

1993 16.7 12.4 13.3 2.9 18.1 74.3 

1994 -1.0 -3.7 2.3 2.7 -2.0 -7.6 

1995 20.5 18.1 19.0 37.2 38.3 -5.5 

1996 11.3 8.7 3.6 23.1 21.6 5.7 

1997 13.3 10.6 0.2 30.5 35.2 -11.8 

1998 3.0 11.0 15.3 38.7 15.6 -25.6 

1999 2.5 1.3 -4.3 33.1 7.3 66.0 

2000 -5.1 10.7 1.6 -22.4 7.0 -30.8 

2001 4.5 6.3 -1.0 -20.4 -5.6 -2.6 

2002 -1.9 8.0 19.5 -27.9 -15.5 -6.2 

2003 28.1 2.0 14.9 29.8 30.0 55.8 

2004 10.9 4.8 10.4 6.3 16.5 25.6 

2005 2.7 5.1 -6.9 5.3 7.1 34.0 
APPENDIX 

 Ennis Knupp + Associates 13.3 

Annual Returns (1970 – 2005) 

Year 

MSCI U.S. 

REIT Index 

DJ Wilshire 

REIT Index 

FTSE 

NAREIT 

Equity 

REITS 

Lehman 

Brothers 

Inflation 

Linked 

Index 

Goldman 

Sachs 

Commodity 

Index 

1970 -- -- -- -- 15.1% 

1971 -- -- -- -- 21.1 

1972 -- -- 8.0% -- 42.4 

1973 -- -- -15.5 -- 75.0 

1974 -- -- -21.4 -- 39.5 

1975 -- -- 19.3 -- -17.2 

1976 -- -- 47.6 -- -11.9 

1977 -- -- 22.4 -- 10.4 

1978 -- 11.0% 10.3 -- 31.6 

1979 -- 49.0 35.9 -- 33.8 

1980 -- 33.1 24.4 -- 11.1 

1981 -- 17.9 6.0 -- -23.0 

1982 -- 20.9 21.6 -- 11.6 

1983 -- 32.2 30.6 -- 16.3 

1984 -- 21.9 20.9 -- 1.1 

1985 -- 6.5 19.1 -- 10.0 

1986 -- 19.7 19.2 -- 2.0 

1987 -- -6.6 -3.6 -- 23.8 

1988 -- 17.5 13.5 -- 27.9 

1989 -- 2.7 8.8 -- 38.3 

1990 -- -23.4 -15.4 -- 29.1 

1991 -- 23.8 35.7 -- -6.1 

1992 -- 15.1 14.6 -- 4.4 

1993 -- 15.1 19.7 -- -12.3 

1994 -- 2.7 3.2 -- 5.3 

1995 12.9% 12.2 15.3 -- 20.3 

1996 35.9 37.0 35.3 -- 33.9 

1997 18.6 19.7 20.3 2.1% -14.1 

1998 -16.9 -17.0 -17.5 3.9 -35.7 

1999 -4.6 -2.6 -4.6 2.4 40.9 

2000 26.8 31.0 26.4 13.2 49.7 

2001 12.8 12.4 13.9 7.9 -31.9 

2002 3.6 3.6 3.8 16.6 32.1 

2003 36.7 36.2 37.1 8.4 20.7 

2004 31.5 33.1 31.6 8.5 17.3 

2005 12.1 13.8 12.2 2.8 25.6 
APPENDIX 

 Ennis Knupp + Associates 13.4 

Correlations (Based on 18-years of data ending December 31, 2005)

C Fund S Fund I Fund F Fund G Fund 

C Fund 1.00 -- -- -- -- 

S Fund 0.80 1.00 -- -- -- 

I Fund 0.62 0.56 1.00 -- -- 

F Fund 0.18 0.09 0.08 1.00 

G Fund 0.01 0.05 0.09 0.14 1.00 

MSCI EAFE Small Cap 

Index1 0.70 0.76 0.88 -0.11 0.11 

ML High Yield Index 0.49 0.54 0.36 0.27 0.20 

Citigroup WGBI 

Hedged 0.17 0.06 0.13 0.88 0.13 

Citigroup WGBI 

Unhedged 0.05 0.01 0.36 0.54 0.22 

Russell 1000 Growth 

Index 0.95 0.85 0.58 0.14 0.01 

Russell 1000 Value 

Index 0.91 0.68 0.56 0.20 0.02 

MSCI Emerging 

Markets Index 0.59 0.64 0.57 -0.04 0.07 

MSCI U.S. REIT Index2 0.28 0.34 0.29 0.05 0.04 

DJ Wilshire REIT 

Index 0.34 0.41 0.24 0.16 0.09 

FTSE NAREIT Equity 

REITS 0.37 0.44 0.27 0.20 0.10 

Lehman Brothers 

TIPS Index3 -0.17 -0.14 -0.14 0.77 0.22