By: Lyn Alden

As I’ve written about before, the TSP is an incredible investment platform.

The fees are extremely low, it provides access to diversified equity and bond investments, and the G Fund, while low in absolute returns, offers the best risk/reward ratio of any investments issued by the U.S. Treasury. My only criticism the whole platform is that the I Fund should follow a broader international index rather than the highly concentrated MSCI EAFE index.

Today, I figured I’d take a magnifying glass to the F Fund, which doesn’t get a lot of love. In all the lifecycle funds from “L Income” through “L 2050”, the F Fund is a much smaller component than the G Fund. With only $26 billion in assets, there is less money in the F Fund than any other TSP fund.

F Fund Overview

The F Fund follows the Bloomberg Barclays U.S. Aggregate Bond Index, which is a flagship index that is meant to represent investment grade debt in the United States.

Here’s the breakdown:

Source: TSP F Fund Fact Sheet

As you can see, it’s divided almost evenly in thirds. One third consists of high-grade corporate bonds, which are labeled vaguely as “credit” on the chart. Another third is asset-backed securities, which essentially refers to mortgage-backed securities. The last third, and the biggest chunk overall, consists of U.S. treasuries.

If I have one small gripe with the F Fund, it’s that last third. For most investors, this index is the perfect broad-based bond fund to invest in, because it covers a nice chunk of the country’s public and private debt. But when combined with the G Fund, there is unnecessary overlap for treasuries. If you hold, say, 50% of your bonds in the G Fund, and 50% in the F Fund, then rather than having an even split of government and private debt like you might believe, you’ll instead have two-thirds government debt and one-third private debt.

There are no foreign bonds in the fund, or anywhere in the TSP. Many asset managers these days include international bonds for diversification. Vanguard’s lifecycle and automatically-rebalancing “LifeStrategy” funds, for example, include international bonds in addition to U.S. bonds. The TSP lacks them, and that’s not really a problem in my opinion, especially for a retirement account.

Lastly, there are no municipal bonds, and for good reason. Municipal bonds are tax-exempt, and thus not ideal investments for a tax-deferred retirement account like the TSP.

Principal Risk: Interest Rates

The F Fund has beaten the G Fund by slightly over 1% per year since inception, on average. The F Fund has given a bit over 6% returns while the G Fund has given only a bit over 5% returns.

This is in exchange for a slight bump in volatility. The G Fund doesn’t decrease in value, while the F Fund has had three negative years since inception, in 1994, 1999, and 2013. Two out of three of those decreases were due to sharp increases in the Federal Funds Rate, while the third one was due to quantitative easing. The impact was minimal, though, as it never lost more than 3% of its value in any of those years.
Because the F Fund has an average maturity of 5-6 years for the bonds it holds, a sharp 1% increase in the Federal Funds Rate can cause a 5-6% drop the value of the F Fund.

In addition, a more lingering risk is to have a long-term low interest rate environment, as we have now.

These are the historical returns of the F Fund:

Source: TSP F Fund Fact Sheet

The rate of return of the F Fund has consistently deteriorated, and this is due to the long-term decline in interest rates set by the Federal Reserve:

Source: Federal Reserve Bank of St. Louis

Now, interest rates are inching back up, but they will most likely be brought back down next time we encounter a recession. We can’t know for sure.

Overall, the F Fund is a good way to add diversified bond exposure to your TSP, but long-term returns going forward are unlikely to be what they were in the 1990’s.

Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.