Independent advice for the institutional investor FINAL I Fund Benchmark Evaluation for the Federal Thrift Savings Plan I FUND BENCHMARK EVALUATION (This page left blank intentionally) TABLE OF CONTENTS 1 Executive Summary 2 Non-U.S. Equity Benchmark Review 3 Implementation of a Daily-Valued MSCI ACW ex-U.S. Index Fund (This page left blank intentionally) ƒƒƒEXECUTIVE SUMMARY Executive Summary The Federal Retirement Thrift Investment Board (FRTIB) requested that Ennis Knupp & Associates (EnnisKnupp) evaluate the appropriateness of changing the benchmark of the International Stock Index Investment Fund (I Fund) offered within the Thrift Savings Plan (TSP). The I Fund’s existing benchmark is the MSCI EAFE Index, which provides exposure to 21 developed non-U.S. equity markets across Europe, Australasia, and the Far East. In this report, we review the appropriateness of changing the I Fund’s benchmark to the MSCI All-Country World (ACW) ex-U.S. Index. The MSCI ACW ex-U.S. Index provides broader and more diversified coverage of the non-U.S. equity markets as it includes exposure to the emerging markets and Canada, in addition to the countries that are in the MSCI EAFE Index. In evaluating the appropriateness of making a change to the I Fund’s mandate, we took into consideration: The criteria set ...
I Fund Benchmark Evaluation for the Federal Thrift Savings Plan
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TABLE OF CONTENTS Executive Summary Non-U.S. Equity Benchmark Review Implementation of a Daily-Valued MSCI ACW ex-U.S. Index Fund
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EXECUTIVE SUMMARY Executive Summary The Federal Retirement Thrift Investment Board (FRTIB) requested that Ennis Knupp & Associates (EnnisKnupp) evaluate the appropriateness of changing the benchmark of the International Stock Index Investment Fund (I Fund) offered within the Thrift Savings Plan (TSP). The I Fund’s existing benchmark is the MSCI EAFE Index, which provides exposure to 21 developed non-U.S. equity markets across Europe, Australasia, and the Far East. In this report, we review the appropriateness of changing the I Fund’s benchmark to the MSCI All-Country World (ACW) ex-U.S. Index. The MSCI ACW ex-U.S. Index provides broader and more diversified coverage of the non-U.S. equity markets as it includes exposure to the emerging markets and Canada, in addition to the countries that are in the MSCI EAFE Index. In evaluating the appropriateness of making a change to the I Fund’s mandate, we took into consideration: ThecriteriasetforthintheFederalEmplotiyr e ems’enRteSystemActof1986(FERSA)thatgoverntheselectionofabenchmarkfortheaInFdutnhdeinvestmentofassetsoftheFund. The merits and challenges associated with moving to the more diversified benchmark and the appropriateness of the MSCI ACW ex-U.S. Index as a benchmark for the I Fund that is in line with the intent specified in FERSA. BGI’s ability to manage a daily-valued fund benchmarked to the MSCI ACW ex-U.S. Index at a reasonable level of tracking error consistent with the guidelines provided in FERSA i.e., to have a fund whose exposures are closely in line with that of the benchmark index. InSection1ofthisreport,wecomparethecshtiacrsaocftetrhieMSCIEAFEIndextothatoftheMSCIACWex-U.S. Index and the MSCI ACW ex-U.S. IMI. We conclude that the MSCI ACW ex-U.S. Index provides broadercoverageoftheinternationalequitymabrketettesradnivdersificationoftheIFund’sinternationalequityexposure.Inditaidontotheinvestmentmerits,theAMCSWCeIx-U.S.Indexalsomeetsthecriteriaset forth in FERSA relating to the selection of a benchmark index for the I Fund. As such, we favor considering a move to a broader benchmark to t h eateBxtGeInitsabletomgaena daily-valued fund at a reasonable level of tracking error and maintain exposures that are closely in line with the index. In Section 2 of this report, we evaluate the construction methodology proposed by BGI to implement a daily valued fund benchmarked to the MSCI ACW ex-U.S. Index. While BGI is able to create and manage a daily valued fund at a reasonable level of tracking error, the proposed construction methodology will result in rebalancing of portions of the fund on a weekly or bi-monthly basis. As a result, in between rebalancing periods, the Fund could have exposures that are different from that of the benchmark index, even though these differences may be small. This appears to be in conflict with the intent of FERSA, which requires the proportionofeachsecurithyeiInFtundtocloselymatchthatofthebenchmarkindex.Assuch,werecommend that the TSP defer a move to a broader benchmark for the I Fund until such time that BGI is abletomanageadaily-valuedfundatareasvoenlaobflterlaeckingerror,whichisalsorebalancedonadaily basis. Ennis Knupp + Associates 1.1
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Ennis Knupp + Associates
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NON-U.S. EQUITY BENCHMARK REVIEW Section 1: Non-U.S. Equity Benchmark Review ThissectionofthereportcomparesthecharactdericsotimcspoasnitionoftheIFund’scurrentbenchmark,theMSCIEAFEIndex,tothatoftheMSCIACWex-U.S.Insdoexp.roWveidaelabriefoverviewofthebenefitsandchallengesassociated with the TSP moving to a broader benchmark. For comparison purposes, we have also included the characteristics of the MSCI All-Country World ex-U.S. InvestableMarketIndex(IMASCCWex-U.S.IMI).Thisindex,recue n ctlhyeldabyMSCI,isbroaderthantheMSCIAll-CountryWorldex-U.S.benchmarkandseekstocofotvheer i9n9ve%stableinter n a tliomarket including small capsecurities.Wearenot,however,recommendingtoathcehaMngSeCIACWex-U.S.IMIatthistimegiventhatitis not yet the mainstream benchmark for institutional investors or asset managers, the lack of significant ind assets currently managed to this index, and the illiquidity that exists within the small cap segment of the be Characteristic Comparison Table 1 shows a comparison of the various characteristics of the three benchmarks. As of 12/31/2008 MSCI EAFE Index MSCI ACWI ex-U.SM. SCI ACWI ex-U.S. Index Investable Market Index Number of Countries 21 47 47 Market Capitalization $7.76 trillion $10.16 trillion $11.29 trillion ($ Float) Country Market 85 85 99 Coverage (%) Turnover (%) 0.86 0.95 0.76 Largest Company Nestle Nestle Nestle (Market Cap) ($149.7 billion) ($149.7 billion) ($149.7 billion) Smallest Company Anglo Irish Bank Corp PIK Group GDR New Star Asset Mgmt. (Market Cap) PLC ($95.2 million) ($4.7 million) ($180.7 million) As shown above, the MSCI ACW ex-U.S. Index is a broader benchmark that includes Canada and the eme markets(26additionalcountries).Inaddition,thceapmit a rlikzeattionoftheMSCIACWex-U.S.Indexis$10.2trillionversusMSCIEAFE’smarketcapitalizatioinlli o fn$.7A.8s tprreviouslymentioned,theMSCIACWex-U.S.IMI is a broader index than the other two international benchmarks and targets 99% versus 85% market ca coverage at the country level. The main reason for this is the MSCI ACW ex-U.S. IMI’s coverage of the sm segment of the international market. This is evident when comparing the market capitalization for the small companyintheMSCIACW.Se.xI-MUIat$4.1milliontothatoftheMSCIACWex-U.S.Indexat$95.2million. Ennis Knupp + Associates 2.1
NON-U.S. EQUITY BENCHMARK REVIEW Table 2 Developed Markets Australia Austria Belgium Canada Denmark Finland France Germany Greece Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Portugal Singapore Spain Sweden Switzerland United Kingdom Emerging Markets Argentina Brazil Chile China Colombia Czech Republic Egypt Hungary India Indonesia Israel Jordan Korea Malaysia Mexico Morocco Pakistan Peru Philippines Poland Russia South Africa Taiwan Thailand Turkey Total Developed Total Emerging