G Fund

Securities and returns
G fund securities are non-marketable U.S. Treasury securities with 1 business day maturities (up to 4 days on holiday weekends). The rate is set by a statutorily prescribed formula which is determined by the weighted average of all treasuries with maturities 4 years or more.

Key Features
• The G Fund offers the opportunity to earn rates of interest similar to those of long-term Government securities but without any risk of loss of principal.

• The objective of the G Fund is to maintain a higher return than inflation without exposing the fund to risk of default or changes in market prices.

• The interest rate resets monthly and is based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity.

• Earnings consist entirely of interest income on the securities.

• Interest on G Fund securities has, over time, outpaced inflation and 90-day T-bills.

G fund and TIPS
You can read Ennis Knupp + Associates recommendation to the FRTIB about  TIPS (Treasury Inflation Protected Securities) and the G fund here, "Investment Option Review Report, October 2006". www.frtib.gov/pdf/FOIA/Investment-Option-Review-FINAL_10-2006.pdf

Of particular interest is: ''Importantly, TSP participants are offered inflation protection via the G Fund. As yields of nominal U.S. Treasury securities generally reflect expected inflation plus a real return component, if inflation increases or is expected to increase, the yields of Treasuries are expected to increase; and the G Fund’s yield should increase as well. The benefit TSP participants have is that the principal value of their G Fund investments does not decline - as a result they do not experience any price volatility. Investors who purchase nominal bonds or TIPS do incur price volatility, which makes the G Fund much more attractive. The characteristics of the G Fund provide a powerful diversification benefit and negate much of the benefits a TIPS fund could provide to TSP participants.''

Over a long observation period, the G fund is expected to have returns on par (or above) TIPS. In withdrawal phase portfolios where volatility can make an impact in portfolio survivability, G fund may be preferable. Although G Fund and TIPS goal of real return are the same, TIPS provide a known real return, whereas the G Fund real return in not known in advance.

G Fund and Inflation
The TSP (Thrift Savings Plan) states the objective of the G Fund is to maintain a higher return than inflation without exposing the fund to risk of default or changes in market prices.

Nominal treasuries yields can be considered to have three components: an inflation forecast, a real return above inflation forecast, plus an inflation risk premium. Just like nominal bonds, G fund will outpace inflation during periods of expected inflation, and disinflation/deflation. However, unlike nominal bonds, G fund does not lose value in a rising rate (rising inflation) environment. The G fund yields will start averaging up every month as new nominal treasuries are issued with the new inflation estimates in their returns. However, there may be a period where inflation outpaces G fund returns.

Over a long observation period, the G fund is expected to outpace the growth of inflation. The premiums returned over inflation during periods of expected inflation and unexpected disinflation, compensate for the possible lagging returns when inflation is unexpected. The data from TSP supports this. Due to the averaging effects, G fund related securities under paced inflation for 1979 and 1980, but significantly outperformed the subsequent year as G fund related securities rates averaged down, so that by 1981 the G fund related securities had recovered the deficit of the previous two years.

source: www.tsp.gov