Federal Thrift shift would mean asset windfall, low fees for manager

Index fund managers vying next year for the biggest RFP in U.S. history — managing $150 billion for the Federal Thrift Savings Plan — need to be prepared to do it on the cheap, perhaps only for profits from securities lending.

BlackRock Inc., New York, currently manages all four of TSP's passive commingled funds that will come up for bid in 2012.

The $287 billion federal thrift plan, a defined contribution plan, is the largest retirement plan in the nation; it overtook the $228 billion California Public Employees' Retirement System for that honor in 2009.

If TSP officials continue their nearly quarter-century tradition of awarding management of all four index funds to a single manager, the $150 billion mandate will be the largest ever in the U.S., said David F. Holmes, partner at Eager, Davis & Holmes LLC, Louisville, Ky.

Mr. Holmes said in an e-mail that the largest previous search was in 2003, when an $18 billion equity index fund manager was sought by the now-$52 billion Washington State Investment Board, Olympia. Barclays Global Investors won the Washington mandate.

BlackRock inherited the TSP business through its 2009 acquisition of BGI. BlackRock and predecessor firms have run the money for 24 years.

“Although the organizational name and affiliation has changed a number of times — from Wells Fargo Institutional Investors to Nikko Investment Advisors to Barclays Global Investors and now BlackRock — the same group of financial professional based in San Francisco has won the competitive bids for the TSP asset management contracts since they were first issued in 1988,” Thomas Trabucco, director of external affairs at Washington-based TSP, said in an e-mail.

BlackRock executives no doubt are keen on retaining the TSP business, which represented about 44% of BlackRock's U.S. defined contribution assets as of June 30 and 4.1% of the $3.7 trillion BlackRock managed for all clients as of the same date.

Besides BlackRock, index fund managers large enough to handle such a big assignment include Northern Trust Global Investments, BNY Mellon Asset Management, State Street Global Advisors and Vanguard Group Inc., sources said.

Officials at all four firms declined to comment on the possibility of bidding on the TSP business next year.

Pensions & Investments estimates winning the TSP assets would increase Northern Trust's U.S. defined contribution assets by 322%; BNY Mellon's by 255%; SSgA's by 89% and Vanguard's by 41%, based on Dec. 31 data provided to P&I.

But the prestige of managing a big chunk of the nation's largest defined contribution plan is probably a bigger motivation than the economics of the deal.

Information on the plan's website shows net administrative expenses including “the management fees for each investment fund and the costs of operating and maintaining TSP's record-keeping system” were 2.4 basis points for the S Fund (U.S. small-cap stock) and 2.5 basis points for each of the other funds. The TSP does its own record keeping with support from some outside vendors.

Industry sources speculate BlackRock is not charging an investment management fee. “At 2.5 basis points, the fee is just too thin. The lowest fee I've ever seen for even the most plain-vanilla equity index fund is 10 basis points,” said a securities lending specialist who asked for anonymity.

“No one is going to be able to compete for this business on price because it's effectively zero,” said Justin White, associate director, Casey, Quirk & Associates LLC, Darien, Conn.

Mr. White, a defined contribution plan specialist consultant to money managers, said “participants in traditional corporate 401(k) plans could never pay this low a fee for plan management. Only the federal government could offer a plan at such a low fee.”

Securities-lending revenue on the fund's three equity index funds are the likely source of profits for BlackRock, said Mr. White.

Neither Mr. Trabucco nor BlackRock spokeswoman Lauren Trengrove would discuss the details of the profits generated by BlackRock from its management of TSP's securities-lending program.

However, the anonymous securities-lending specialist agreed with CQA's Mr. White that “there is no way that BlackRock could be managing these assets at something less than 2.5 basis points in fees without securities-lending income.”

The specialist estimated that BlackRock could generate $91 million per year in securities-lending revenue on TSP's $130 billion in equity index assets. Applying the typical revenue split of 60% to the plan sponsor and 40% to the money manager, BlackRock's cut would be about $36 million.

Few details are available about the RFP that will be issued next year for managers to run the $287 billion plan's four externally managed investment options. Mr. Trabucco confirmed in an interview that RFPs should be issued next year “when they are ready.” He said the plan's general consultant, Hewitt EnnisKnupp, is assisting.

Up for bid: the F Fund, a U.S. fixed-income index fund, which totaled $20.4 billion as of July 31; the $78.2 billion C Fund, a U.S. common-stock index fund; the $27.4 billion S Fund, a U.S. small-cap equity index fund; and the $24.4 billion I Fund, an international stock index fund.

The index options of the fund were last rebid in 2006, Mr. Trabucco said in the e-mail. By law, all of TSP's externally managed investment options must be passively managed.

The G fund, which totaled $137.7 billion as of July 31, is managed internally with the U.S. Treasury in government securities. It is not up for tender.

Reporter Hazel Bradford contributed to this story.