Pursuing Sustainability Goals Within TSP

In 2022, TSP introduced the Mutual Fund Window (MFW), responding to years of calls for more investment choices. TSP participants now have the ability to invest for their retirement outside of the traditional “alphabet” funds: C, S, G, I and F. As of December 2023, there are more than 4,500 funds offered through the MFW.

There are significant administrative hurdles that reduce the attractiveness of using the MFW, and of course many TSP participants are well-satisfied by the normal selection of funds. According to TSP’s most recent annual report, as of December 2023, there are 4,206 MFW accounts with assets totaling $284 million. (For context, there are approximately 7 million TSP participants overall; assets in the letter funds exceed $800 billion.)

However, a particularly strong use case for the MFW is that it gives TSP participants the ability to direct their retirement accounts to funds that reflect their environmental sustainability, social and governance accountability objectives. According to Morningstar, US investors have poured $335 billion into ESG (environmental, social, governance)-focused funds, as of the first quarter of this year. 

What are the ESG options in the Mutual Fund Window?

I identified 42 funds in the MFW that carry the phrase “ESG” in their title. These can be sorted into three broad categories:

• Actively Managed Equity Funds
• Passively Managed Index Equity Funds
• Fixed Income Funds

Within those categories, you will find some funds that invest purely in US-based companies and some that include international offerings (including emerging markets). A sizable number of the funds are balanced funds (e.g., they contain both stocks and bonds), including a selection of retirement target date funds.

One of the greatest charms of the traditional TSP fund lineup is its low cost. For example, the annual expense ratio for the C Fund is 0.048%; that’s $4.80 for a $10,000 account balance.

Within the MFW, there are actively managed funds that carry expense ratios above 1.00% (more than $100 per $10,000 of account balance). And we all know from research that actively managed funds have not historically out-performed passively managed index funds. However, as I will discuss later, some investors may find that fee worth paying as the price of ensuring that their investment is aligned with their values.

So how do I pick an ESG fund?

As always, your investment decision will be guided by your risk preferences and your time horizon. From there, you will decide on the asset allocation (stocks versus bonds) that makes sense for you, bearing in mind that not more than 25% of your TSP balance can be invested through the MFW’s offerings.

With that determined, the next step is to articulate what specific ESG-related goal you are looking to express through your choice of fund.

A common criticism of the ESG investing industry is that there is no one definition of what “ESG” means, but I think that is actually a strength. Many ESG investors wish to entirely avoid fossil fuel investments while others specifically want to reward those oil and gas companies that they believe are acting responsibly. Others avoid industries such as weapons, tobacco, and prisons. Some investors care most about a company’s inclusive hiring practices. The diversity in ESG fund choices, while possibly overwhelming, provides an opportunity for each investor to tailor their portfolio to their specific social and sustainability goals.

With this in mind, let’s return to the choice between an actively managed fund and an index fund. An ESG index fund, like any index fund, is designed to track the performance of an index comprised of a certain selection of companies. In this case, the MFW offers funds that are based on MSCI ESG indexes. And so, the decision about whether an index ESG fund is sufficient for meeting your objectives starts with an understanding of how these indexes are constructed.

On the other hand, an actively managed fund may offer the opportunity to more finely tailor your choices, for example, choosing funds that specifically exclude the fossil fuels industry. In addition, an active ESG fund manager does more than choose companies based on their expected market performance. Some ESG funds take an active role in corporate governance, using their influence to change how the companies in which they invest behave. All of this is to say that the choice between active and passive fund management is a more nuanced discussion in the ESG space.

Looking under the hood of your potential fund choices starts with visiting the website of the fund manager. From there you should be able to easily access the fund’s investment philosophy, its top holdings, and its cost. But even before that, resources such as Morningstar and the US Sustainable Investment Forum are excellent educational outlets to increase your knowledge of ESG investing more broadly.

Lisa Whitley is an Accredited Financial Counselor (AFC®) and Chartered Retirement Planning Counselor (CRPC®). After an 18-year federal career, Lisa became a personal finance coach & planner in 2019. Her firm, MoneyByLisa, is a Registered Investment Advisor domiciled in the District of Columbia.