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Fee rises strain mutual loyalties

Is TIAA-CREF losing its soul? Certainly it’s losing some business and critics have started questioning the results of the ‘Merrillisation’ of this $360bn (e303bn) management company founded 87 years ago by philanthropist Andrew Carnegie as a non profit organisation to provide low-cost retirement plans and insurance for teachers and researchers in the United States.
The ‘Merrillisation’ - a market oriented and efficiency aware business model - started three years ago with the arrival of the new chief executive officer Herbert Allison, a tough Wall Street manager who had worked 28 years with Merrill Lynch.
Allison wanted to transform the Teachers Insurance and Annuity Association College Retirement Equities Fund into a more efficient, more flexible, less bureaucratic company. He immediately cut 500 or 8% of its 6,500 employees in reorganising the back office and computer department. He also revamped the retail mutual fund business and opened the first storefront offices for the general public.
Last summer he tried to increase fees (sometimes up to quadruple) on nine of its mutual funds that are offered within the state-managed college savings plans, known as 529 plans after the section of the US federal tax code that allows states to organise tax-deferred or tax-free educational savings accounts. It is a market that in the US has boomed from $2.6bn in 2000 to more than $52bn in 2004, with increasingly intense competition among financial services.
TIAA-CREF was initially favoured as a provider because of its roots and its low costs. Too low, according to Allison, who declared in a statement filed with the Securities and Exchange Commission that the increased fees will allow “these funds to cover their costs of operation while remaining competitive with lower-priced offerings in the industry. Even though much of TIAA-CREF runs on a non-profit basis, our operations must be financially self-sustaining over time.”
The problem is that the proposal came at a time when fees in the mutual-fund industry overall are declining. So in August it was rejected by the majority of the mutual funds’ shareholders, among which are the state-run college savings plans that contract management of their plans to TIAA-CREF and offer the firm’s funds to plan participants. Allison contacted these institutional investors to better explain the impact of the negative vote that could be closing, merging or liquidating the funds.
According to TIAA-CREF “certain large institutional shareholders might be willing to re-examine the proposal”. That’s why it has scheduled a new vote for the end of January for eight of the concerned funds – International Equity, Small-Cap Equity, Large-Cap Value, Real Estate Securities, Social Choice Equity, Bond, Inflation-Linked Bond and Money Market Funds. TIAA-CREF is not seeking a second vote on the ninth fund, Growth Equity Fund, which has provided poor returns to investors in recent years, because “shareholders of this fund were unlikely to change their votes”.
The Growth Equity Fund is a perfect example of the controversy: 46% of its shares are owned by the Missouri Saving for Tuition plan, known as MO$T, which since its inception in 1999 hired TIAA-CREF as the 529 plan’s provider. But the fund’s poor performances plus the proposed increased fees have triggered the decision by the Missouri State Treasurer Sarah Steelman to put the programme up for bid.
The contract with TIAA-CREF expires next May and Steelman has made clear that she wants to keep expenses low, because low-load funds are the foundation of the 529 programme. Besides TIAA-CREF, five other financial services firms are bidding to manage the $750m MO$T plan.
TIAA-CREF manages 529 plans in 12 states, more than any other financial services company, but in August 2003 it already lost the first contract – on its very turf, New York, where the company is based. The New York State 529 college-savings plan’s management went to Vanguard and to Columbia Management Group (a unit of FleetBoston Financial), which offered lower costs. California renewed TIAA-CREF’s contract to manage its $1.7bn 529 plan, but last August voted against the fee increase.
Mutual funds represent only $12bn of assets under management for TIAA-CREF, but Allison’s new style risks alienating the loyalty of states, colleges and individual teachers to the non-profit company. Allison’s insistence on raising fees might be interpreted as defying shareholders’ wishes, according to Christopher Davis, who follows TIAA-CREF’s funds for Morningstar, and low cost competitors like Vanguard are likely to gain ground.

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