The Biggest Fund You Never Heard Of

Pension heavyweight TIAA-CREF is retailing mutual funds

For years, the Vanguard Group has preached the gospel of low costs to mutual-fund investors. As its simple message has caught on, Vanguard has become the nation's second-largest and fastest-growing fund firm. Now, a new rival, known by the unwieldy acronym TIAA-CREF, is challenging this colossus with a low-cost message refined over eight decades of managing pension funds for colleges, universities, and nonprofits. "No one has ever competed successfully with Vanguard," says Burton J. Greenwald, a Philadelphia mutual-fund consultant. "Now, for the first time, there is a competitor with enormous credibility."

MAGELLAN WHO? Although it is virtually unknown, TIAA-CREF is no upstart. With $268 billion under management, TIAA-CREF--which stands for Teachers Insurance and Annuity Association-College Retirement Equities Fund--is the world's largest pension system. If it were a fund company, it would rank as the nation's fourth-largest. And its flagship product--a $123 billion variable annuity--dwarfs Fidelity's Magellan, the nation's largest mutual fund.

Still, while TIAA-CREF is a giant, it is a nobody to the public. That's because in 1920, Congress granted the pension heavyweight a tax exemption that was contingent on it focusing exclusively on retirement products for the nonprofit and education fields. When rivals persuaded Congress to revoke the exemption in 1997, TIAA-CREF was free to enter new businesses. "We're the world's largest unknown fund," says Chief Investment Officer Martin L. Leibowitz.

AMBITIOUS ARRAY. But now that the tax exemption's golden handcuffs are gone, the sleeping giant is starting to make its presence known. As if to make up for its late start, the nonprofit has introduced an ambitious array of retail products. Over the past two years, TIAA-CREF has launched six mutual funds, a trust company, a business managing money for state-sponsored college savings plans, and a low-cost, aftertax annuity it plans to take nationwide this fall. The year 2000 will bring two new mutual funds and life insurance designed to cover estate taxes. All employ the low-cost approach Vanguard has made famous: "We're the first institution to compete with Vanguard on quality grounds," says TIAA-CREF's chairman, John H. Biggs.

That TIAA-CREF is emulating Vanguard isn't surprising. Both are nonprofits that charge no more than it takes to cover their expenses including rent and salaries. And each relies mainly on an investment approach that replaces high-paid stockpickers with formulas that mechanically replicate stock market indexes, such as the Russell 3000 and Standard & Poor's 500-stock index.

"VULTURE." Principals in both outfits admire the other company, as well. Vanguard founder John C. Bogle has praised TIAA-CREF as a "low-cost vulture." And before TIAA-CREF began venturing on Vanguard's turf, Biggs frequently steered the company's pensioners to Vanguard. "We share a deep sense of cheapness on the part of our customers," says Leibowitz of his rival.

As a result, consumers pay charges that are among the lowest around. While TIAA-CREF pockets from 0.29% to 0.49% for every $100 invested in its mutual funds, Vanguard charges 0.28%, on average. That's about one percentage point less than the industry's norm of 1.37%.

Although 1% may seem insignificant, those savings give investors a head start that compounds over time, resulting in a powerful performance edge. Like Vanguard, TIAA-CREF boasts a strong record. Its flagship variable annuity--19% of which is invested overseas--had an average annual return of 16.16% over the past decade, vs. 13.85% for the average stock fund. As is typical of TIAA-CREF, the fund uses an "enhanced indexed" approach. About 75% of its assets are indexed, while the remainder are managed by stockpickers.

Like the pace of its new-product introductions, TIAA-CREF's goals are anything but cautious. Biggs figures that within a decade, three of the new businesses could be attracting as much new money as the pension system, which at $265 billion currently accounts for 99% of the firm's assets. Last year, pension inflows totalled $7.9 billion.

Clearly, TIAA-CREF has a long way to go. The aftertax annuity, which Biggs expects to capture 5% to 10% of the market in five years, is barely off the ground. And at $1.5 billion, the mutual funds are far from their $5 billion breakeven point; and they're light years from the $10 billion in annual inflows, or 2% market share, that Biggs thinks is feasible within a decade. Still, Biggs is undaunted. "We should become a major player," he says.

To do so, TIAA-CREF is counting on support from its 2.1 million pension customers, who represent about 5% of the investing public. "That's a pretty good place to start," says Kenneth R. Hoffman, president of consulting firm Optima Group Ltd.

SCHWAB STORY. To attract a wider following, TIAA-CREF is courting fee-only financial planners--a tactic that Vanguard has mastered. It sends marketing consultants to planners' conferences, and the newly created TIAA-CREF Institute mails advisers scholarly research on investment topics. Once the new products have three-year results, many planners say they will recommend them. TIAA-CREF has "a terrific track record and low expenses. They should be able to get support from fee-only planners," says Bob Wacker, a planner in San Luis Obispo, Calif.

To broaden its distribution, TIAA-CREF has made its mutual funds available through Schwab's huge fund supermarket. And to increase its visibility, the firm has become the investment adviser for seven new state-sponsored programs that encourage college savings, including New York's and California's.

But don't look for the unwieldy acronym to become a household name anytime soon. That's because, in order to contain costs, TIAA-CREF won't do much advertising. Instead, it is imitating Vanguard, whose strong track record generates enough positive press and word-of-mouth to compensate for a tiny ad budget.

Is Vanguard nervous? Not yet. Sure, TIAA-CREF's new products are making their debut in a bull market enamored of low-cost products. But it took Vanguard two decades before it became a sensation. Regardless, the bottom line for investors is that no matter how fast TIAA-CREF expands, its costs won't follow suit.

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