nps wrote: ↑Wed Oct 09, 2019 6:13 am

vineviz wrote: ↑Tue Oct 08, 2019 12:30 pm

tadamsmar wrote: ↑Tue Oct 08, 2019 11:06 am

They are probably assuming F has a somewhat higher return than G. Seems to me that is a reasonable assumption and it looks to be consistent with the facts that we know. The allocations depend on the correlation matrices of the 5 TSP assets.

Sorry, but no. The

**only** way to generate an efficient frontier which contains the L fund allocations is to assume that the two funds have the same expected return. If the consultants had assumed that "F has a somewhat higher return than G", the L funds would have much lower allocations to the G Fund than they actually do.

Actually what tadamsmar stated is exactly what they assumed:

https://www.frtib.gov/pdf/minutes/MM-2018Sep-Att5c.pdf
Slide 14 has their expected return assumptions.

First, slide 14 shows that my statement was correct, not tadamsmar's: the assumptions in the "previous study" column are the ones used to generate the existing L Fund allocations, and the assumed return for G Fund and F Fund were both 3.5%.

Second, it's true that the current return assumptions (which should be used to construct future L Fund allocations) have modified the expected returns to be more realistic with the expected return of F Fund > G Fund. Both are arguably still indefensible, since the expected return is FAR above the current YTM for each fund and the expected volatility of the G fund is about 50% too high, but leave that aside for now.

** Despite changing the ***relative* expected returns for the two funds, the proposed *relative* allocation for the 2018 L Fund allocation hasn't changed at all. Which leads to my third point:

According to the consultant's own assumptions, the L Fund allocations are NOT on their own modeled efficient frontier. Check out slide 15:

Now, in fairness to Aon Hewitt it seems that their mandate is NOT to maximize risk-adjusted return in the classic Sharpe ratio (i.e. efficient frontier) sense but rather to optimize the income replacement ratio for plan participants. Check out slide 18: they are defining "risk" as the 5th percentile outcome for income replacement ratio and "reward" as 50th percentile outcome. This is consistent with their goal as stated in slide 3:

The desired outcome is to create a series of L Funds such that an “average participant” in those L Funds, in combination with the FERS defined benefit plan and Social Security, will be projected to have sufficient assets to maintain a reasonable standard of living throughout retirement.

This is an entirely reasonable goal, even if it is a little opaque without full access to the data they have about plan participants, and it certainly is a quantitative goal. But it means they are NOT trying to allocate the L Funds to be on the Markowitz frontier.

It also means that the L Fund allocation should be appropriate for the

*average* plan participant. Furthermore, in terms of advice I'd

**recommend** the L Funds to

*every* TSP participant before I'd recommend a DIY portfolio. Especially with the more modern, less conservative glide paths.

But virtually NO participant is going to precisely match the AVERAGE participant on every assumed parameter (e.g. age, salary, deferral rate, risk aversion, external assets, life expectancy, etc.). As a result, the L Fund allocations are not likely to be optimal for

**any** investor who is serious about trying a DIY asset allocation. Good enough? Absolutely, but let's not pretend the allocations are magical or even more efficient than they actually are.

"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch