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The TSP's New I Fund Benchmark

The TSP's New I Fund Benchmark

February 15, 2024

Recently the TSP announced it is rolling out a new version of its I Fund (i.e., International Fund). They have decided to change their benchmark for investments in the TSP's I Fund from the MSCI EAFE index to the MSCI ACWI IMI ex USA ex China ex Hong Kong. Bottom Line Up Front: This is largely a good thing for service members and veterans financial well being. Frankly, this change is long overdue. 


What is the Difference Between the MSCI EAFE and MSCI ACWI IMI ex USA ex China ex Hong Kong Indexes?

The MSCI EAFE Index stands for Morgan Stanley Capital Index Europe. Austarlasia (not a typo), and Far East. This index benchmark covers mid to large cap equities in Europe, the Pacific, and Middle East. This index is focused on 21 Developed Markets, which is to say that they represent a relatively low risk cross-section of the global economy.

The MSCI ACWI IMI ex USA ex China ex Hong Kong Index stands for Morgan Stanley Capital Index All Country World Index Investable Market Index excluding USA excluding China excluding Hong Kong Index. This index benchmark covers small, mid, and large cap equities in 22 developed markets and 24 emerging markets.

What the new benchmark will bring to the I fund is an inclusion of small cap equities, 24 Emerging Markets not currently tracked, and a slight increase in Developed Markets. Notably, the new MSCI ACWI IMI ex USA ex China ex Hong Kong benchmark excludes Hong Kong which is now under mainland China's governing system. It appears to be a good thing to exclude them from our portfolio currently, at least until tensions come back down to a reasonable level. Furthermore, the new benchmark also allocates a little over 8% of their portfolio to Canada, which is not present in the MSCI EAFE index. Finally, the new benchmark includes investments in countries located in Central America, South America and Africa.

This provides the I Fund with more diversification, but what about performance?

What is the Difference in Performance Between the Old I Fund and the New I Fund?

This is a tricky analysis to make because the two indices only have seven years of overlapping history to compare. Seven years isn't enough time to make an evaluation with a high degree of confidence. However, we can back into a comparison by looking at the MSCI EAFE Index relative to three other indices. 

Let's look at an example for each. Assuming you had invested $100 in each of the benchmark indexes beginning January 2009, what you could have earned by January 31st, 2024?

  • MSCI EAFE: $304.66 (7.41% annual rate of return)
  • MSCI ACWI ex USA IMI: $321.11 (7.76% annual rate of return)
  • MSCI ACWI ex China IMI: $532.53 (11.14% annual rate of return)
  • MSCI ACWI ex Hong Kong IMI: $518.55 (10.96% annual rate of return)

This demonstrates that in all cases we end with a higher rate of return by including the other assets in our new I Fund benchmark. 

What is the Difference in Risk Between the Old I Fund and the New I Fund?

Here we run into the same problem as we did in measuring performance. There is not enough data to make a convincing argument either way. However, using the same benchmarks as last time for proxies, we can make some assumptions about what the risk measurements might have looked like over the last few decades. For our purposes we look at the standard deviation (a measure of volatility), the Sharpe Ratio (the return of an asset above the risk free rate relative to its standard deviation) and the maximum draw down during the covered period since January 2009.

Lets start with the standard deviation over the most recent ten year period.

  • MSCI EAFE: 15.18
  • MSCI ACWI ex USA IMI: 15.15
  • MSCI ACWI ex China IMI: 15.12
  • MSCI ACWI ex Hong Kong IMI: 14.98

We can again infer a positive outcome from these numbers as the ex China and ex Hong Kong benchmarks have provided a lower volatility portfolio relative to the EAFE Index, AKA a less risky option.

Continuing on to the Sharpe Ratio over the most recent ten year period:

  • MSCI EAFE: 0.29
  • MSCI ACWI ex USA IMI: 0.29
  • MSCI ACWI ex China IMI: 0.56
  • MSCI ACWI ex Hong Kong IMI: 0.55

This is another positive outcome for the new benchmark if we use these proxies to back into a risk adjusted return factor. However, the inclusion of the USA does dilute the risk adjusted return. This suggests that the entirety of the benefit is due to the exclusion of China and Hong Kong from the broader ACWI indices.

Lastly, let's look at the maximum draw down for each index benchmark during the same period:

  • MSCI EAFE: 60.41% (October 31st, 2007 - March 9th, 2009)
  • MSCI ACWI ex USA IMI: 60.80% (October 31st, 2007 - March 9th, 2009)
  • MSCI ACWI ex China IMI: 58.17% (October 31st, 2007 - March 9th, 2009)
  • MSCI ACWI ex Hong Kong IMI: 58.25% (October 31st, 2007 - March 9th, 2009)

Here, we see less of a draw down in the ex China and ex Hong Kong indexes but slightly more of a draw down in the ex USA index. This indicates that excluding the USA from the index made the maximum draw down worse (i.e. the USA had a more robust market during that period) relative to the EAFE index. However, the exclusion of China and Hong Kong from the index resulted in a smaller maximum draw down, which suggests those countries' markets were not as robust as the USA or EAFE markets.

When Will the TSP Make This Change to the New I Fund Benchmark?

We can't say for certain and that's a good thing. The TSP is staying quiet on the exact timing of shifting their assets from their current benchmark to the new benchmark to help them secure competitive prices. Can you imagine letting everyone else in the market know exactly when you were going to sell $68 Billion of assets or buy that much back of another asset class? That wouldn't end well for us. However, we do know the transition will be completed no later than December 31, 2024. 

Disclaimer: This blog post is intended for educational purposes only, it should not be construed as tax advice or financial planning advice. Consult a professional for tax and financial planning advice before making any changes. All photos are from open source domains.