FRTIB Urged to Reverse China Investment

James Kynge and James Politi of the Financial Times report that senior US senators are demanding that one of America’s biggest government pension funds reverse a decision that is set to channel billions of US dollars into funding Chinese companies that they say support Beijing’s military, espionage and domestic security efforts:

The demand shows how the US-China rivalry, which has thus far focused mainly on trade war tensions, is spreading further into the arena of financial markets.

Senators Marco Rubio, a Republican, and Jeanne Shaheen, a Democrat, told Michael Kennedy, chairman of the Federal Retirement Thrift Investment Board, in a letter that his fund is supporting Chinese state-owned companies with “the paychecks of members of the US Armed Services and other federal government employees”.

The letter — a copy of which was seen by the Financial Times — said an impending investment shift by the FRTIB would mean that about $50bn in US government pensions becomes exposed to the “severe and undisclosed” risks of being invested in selected Chinese companies.

The letter, dated August 26, was copied to senior US officials including Mike Pompeo, US secretary of state, and Steven Mnuchin, Treasury secretary.

“The Federal Retirement Thrift Investment Board made a short-sighted — and foolish — decision to effectively fund the Chinese government and Communist party’s efforts to undermine US economic and national security with the retirement savings of members of the US Armed Services and other federal employees,” Mr Rubio told the Financial Times.

“The Federal Retirement Thrift Investment Board should publicly reverse this decision immediately,” added Mr Rubio.

The FRTIB declined to comment.

Mr Rubio, a senior member of the Senate foreign relations committee and a China hawk, has led a push against Chinese companies with ties to the country’s intelligence and military. Ms Shaheen is on the Senate armed services committee.

The FRTIB manages about $578bn in assets in its Thrift Savings Plan and has some 5.5m participants, ranking as one of the US’s largest retirement funds.

Under a 2017 decision to change its investment strategy, a key portfolio is set to be shifted next year into the MSCI All Country World ex-US Investable Market Index, a benchmark index that includes several controversial Chinese companies.

When funds invest in an index, they tend to mirror the selection of stocks that comprise the index. Some 7.6 per cent of the ACWI ex-US IMI is made up of Chinese companies.

The senators’ letter said the MSCI ACWI or its sub-indices include Hong Kong-listed AviChina Industry and Technology, an arm of AVIC, which develops equipment and weapons systems for the People’s Liberation Army Airforce.

It added that the index included China Mobile, which the US Federal Communications Commission voted to bar from entering the US market due to national security concerns earlier this year.

Hangzhou Hikvision, a state-owned Chinese company that sells surveillance cameras to detainment camps in Xinjiang, is also part of the index, or its sub-indices, the letter said.

MSCI confirmed the three companies are all constituents of the ACWI.

Some observers said the issue sends a broader signal to US markets.

“This controversy should send an unmistakable message to Wall Street and other fund managers and index providers that henceforth the material risks associated with Chinese corporate national security and human rights abusers must be taken into proper account,” said Roger Robinson, president and chief executive of RWR Advisory Group, a Washington-based risk consultancy.

I read this article earlier today and it piqued my curiosity. I will discuss the politics and implications at the end of my comment.

First, I had no idea about the Federal Retirement Thrift Investment Board (FRTIB) and learned more about this retirement fund on its website here.

Basically, the FRTIB administers the Thrift Savings Plan (TSP), a tax-deferred defined contribution plan similar to private sector 401(k) plans which provides US Federal employees the opportunity to save for additional retirement security:

Voted three years in a row as one of the "Best Places to Work in the Federal Government" as ranked by the Partnership for Public Service Best Places to Work Rankings, the Federal Retirement Thrift Investment Board (FRTIB) is an independent Federal Agency with a single mission: To administer the Thrift Savings Plan solely in the interest of its participants and beneficiaries.  We help Federal employees and members of the Uniformed Services retire with dignity by providing benefits similar to private sector 401(k) plans. The TSP manages over $390 billion for more than 4.6 million participants located in every time zone around the world.

I found additional information on TSP here:

The TSP is a retirement savings plan for Federal employees and members of the uniformed services; it is similar to the 401(k) plans offered by many private employers. As of July2019, TSP assets totaled approximately $599.5 billion, and retirement savings accounts were being maintained for more than 5.7million TSP participants. Participants include Federal civilian employees in all branches of Government, employees of the U.S. Postal Service, and members of the uniformed services. Additional information can be found at www.tsp.gov

FRTIB is basically the largest defined-contribution plan in the world providing US Federal employees the opportunity to save for additional retirement security.

Ravindra Deo serves as its Executive Director and you can read more about him and FRTIB's board members here.

Next, I went to FRTIB's reading room where you can find all sorts of information including the Federal Employees Retirement System Act, regulations, financial statements, FRTIB's strategic plan, reports to Congress, press releases, as well as participant and employee surveys.

I would encourage you to read FRTIB's 2017-2021 Strategic Plan here to familiarize yourself with their strategic plan on administering the Thrift Savings Plan (TSP).

I then want you to read the latest Investment Option Review (May 2017) which is a benchmark study prepared by Aon Hewitt Investment Consulting (AHIC). You can read the background here:

I then draw your attention to page 6 of the Executive Summary:

As you can read, in evaluating the types of investment fund alternatives to offer in the TSP, 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 (consider asset classes/categories with a market capitalization or investment opportunity set of at least $1 trillion)
• Potential diversification benefit for TSP participant portfolios
• Asset class/category offers daily liquidity and daily valuation
• Ability to index
• Practices of peers

Based on the application of the key criteria discussed above, Aon Hewitt eliminated several categories from further consideration due to factors such as – small market size, illiquidity, lack of passive investment strategies, or concentrated strategies/purpose. Moreover, the asset classes excluded for further consideration were:

• Frontier Market Equities
• High Yield Bonds
• TIPS
• Private Real Estate
• Private Equity
• Hedge Funds
• Socially Responsible/ESGFunds
• Infrastructure

The report provides a summary thoughts on the asset classes/categories that they reviewed in detail and I would encourage you to read through it.

Basically, the Thrift Savings Plan (TSP) invests in very liquid US and global stocks and bonds across various Funds which you can see below (all figures are as at December 31, 2016):

You need to read the entire report by Aon Hewitt Investment Consulting to get the specifics on each fund by at a broader level, but the table below shows the asset allocation practices of TSP according to the Vanguard 2016 survey:

Again, these figures are dated but the report found the following observations:

• TSP participants have slightly lower allocations to core fixed income (F Fund) and target date funds (L Fund) compared to Vanguard’s 2016 survey of defined contribution plans.
• Even when excluding allocations to company stock, TSP participants still have slightly less exposure to equities when compared to its peers.
• TSP participants have the highest allocation to the lowest risk, stable value fund option given the G Fund offering.

Given the global bond and stock market rally since the Great Financial Crisis (2008), it's no surprise that assets of the Thrift Savings Fund have mushroomed over the last ten years. The figures below are taken from the 2017-2018 Financial Statements:

Somewhat surprisingly, however, I glimpsed through the latest Annual Report to Congress but didn't find performance data on each fund, only detailed allocations by demographic cohorts.

However, when I looked at the latest Board Meeting Minutes, I did find the latest Performance Review (along with others) which is available here.

The latest minutes state "for year to date, the F, C and S Funds were in line with the Funds' respective indices. Performance for the I Fund was 43 basis points higher than the International Index, primarily due to tax effect":

Not surprisingly, TSP has separate accounts with BlackRock, the world's largest asset manager:

Still, there's nothing sophisticated going on here, it's primarily investing in very liquid US and global stocks and bonds.

If we get into a period where both stocks and bonds underperform, TSP is in trouble. Even if they don't underperform, low returns are here to stay, something CPPIB's CEO Mark Machin discussed last week when he went over how they're preparing for the next downturn.

Lastly, let me end with a comment on the politics of the investments into questionable Chinese companies. I'm not saying that US senators aren't right to sound the alarm and demand more transparency on which funds are investing in questionable Chinese companies that can impact US security, especially a fund like the Federal Retirement Thrift Investment Board which invests on behalf of members of the uniformed services, but it sets a dangerous precedent when US politicians get involved in fund investments.

The Federal Retirement Thrift Investment Board (FRTIB) is an independent Federal Agency with a single mission: To administer the Thrift Savings Plan solely in the interest of its participants and beneficiaries.

Ideally, there would be no government interference but I understand that in some cases, especially if it concerns military security, it needs to act accordingly and be a lot more sensitive when it comes to these investments.

My fear is a full-blown trade war with China is already degenerating into a currency war, and if high-profile US senators start demanding large US pensions to divest from certain companies, the Chinese will respond in kind and it might mean they will refuse to invest in some US companies and funds.

It's a slippery slope, one that will not only affect FRTIB but other large asset managers.

Below, if you are a new civilian federal employee, here’s what you should know about the Thrift Savings Plan. I also included a clip on how to stop, change or start your contributions.

Most of you already know my thoughts on defined-contribution plans, they're fine savings plans over the long run but they are no match for well-governed defined-benefit plans that invest across public and private markets all over the world.

Lastly, US equity futures moved from negative to positive overnight into Monday after President Trump said China called and is ready to come back to the negotiating table, but Chinese officials are denying the claim. CNBC's Eamon Javers reports from France on the latest on the trade war front as well as the details from the G-7 meeting.