by Charles Schwartz, Professor Emeritus, University of California, Berkeley
firstname.lastname@example.org May 29, 2003
>> This series is available on the Internet at
Several Current Topics
A. The Lawsuit
B. How Is the UC Pension Fund Doing?
C. Real Estate Investments
D. More on Risk-Adusted Returns
On April 1 we filed a lawsuit against The Regents of the University of California: "Petition for Writ of Mandate to Compel Release of Public Records (Government Code Section 6259)". My fellow plaintiffs are the Coalition of University Employees (UC clerical workers' union) and San Jose Mercury News. For almost three years I have been complaining about the regents' excessive secrecy in investment decisionmaking and now, with some other concerned citizens and talented lawyers, we are doing something about it.
The suit asks the court to order UC to release
documents in three categories:
1. records showing the performance of private equity investments, especially the "internal rate of return" (IRR);
2. all records, including minutes and tape recordings of the regents' closed meetings in January and March 2000 where the Wilshire Asset Allocation Study was considered, and the October and November 2002 closed meetings concerning the Multiple Manager Equity Investment Strategy;
3. other records that we had previously requested of UC, including records concerning consultations with outside investment professionals.
In addition, the suit asks the court to place clear limits on the circumstances under which the Regents holds investment-related closed sessions in the future.
On May 7, UC's lawyers filed their opposition briefs, which included a host of declarations from venture capital firms and an amicus brief from the National Venture Capital Association, all declaiming what terrible consequences would follow if UC were required by the court to disclose the performance data of the private equity funds in which it invests. This is an industry which is struggling to keep its recent failures hidden, despite the fact that several other public pension funds around the country have already begun to publish the very data that UC is withholding.
I'll just tell you here about how UC has
to one particular issue - #3 on the above list. When UC publicly
announced, last November 26, that the regents had fired their entire equity
investment staff and were planning to send $15 billion out to be managed
by private firms, the official press release stated,
"After extensive consultation with outside investment professionals, as well as the UC Regents' Investment Advisory Committee and the Committee on Investments, Treasurer Russ has recommended that the University transfer the internal management of its U.S. equity investments to multiple external managers." In our lawyer's first request to UC (last December 24), he asked for public release of the University's records concerning those consultations referenced in the press release. UC's lawyers replied, on January 22, that "we have confirmed that the University has no responsive documents that correspond to the documents indentified" in our request. Our lawyers' brief filed with the court said about this item: "UC's response, given the nature of the requests and the magnitude of the investments it manages, is highly suspect." In UC's latest brief we now find a whole new story: "While the language of the press releases may have inadvertently suggested that other experts were consulted outside of those on the IAC [Investment Advisory Committee], in fact there were no such additional consultations."
Some further details about the lawsuit may
be found on my website. A hearing is now scheduled for June 24 in
Dept. 31 of the Alameda County Superior Court.
B. How Is the UC Pension Fund Doing?
Occasionally I encounter a reader of this series who asks me bluntly, Well, Schwartz, how bad off is the pension fund? Here is some pertinent information gathered following the April 22 meeting of the Regents' Committee on Investments.
Stephen Nesbitt, the consultant from Wilshire Associates, gave a brief presentation to the regents, summarizing the services he provides and showing some data his firm collects which allows a comparison of many public pension funds across the country. He showed a graph displaying the distribution of the "Funding Ratios" for 123 statewide retirement systems. This number is the ratio of pension fund Assets (at market value) to Liabilities (the actuarial accrued liability). A funding ratio of more than 1.0 means that the plan is overfunded; the majority of pension plans, however, are underfunded. Nesbitt's graph designated UCRP as ranking #6 in the nation, with a funding ratio of 1.17, which was intended to imply a certain sense of pride and satisfaction among the regents.
I picked up a copy of the full report, "2003 Wilshire Report on State Retirement Systems: Funding Levels and Asset Allocation," and took a closer look at the data. It turns out that the data he collected and tabulated showed a wide spread in the Valuation Date for each entry (see his Appendix A): from 6/30/2002, to 6/30/2001, to 6/30/2000 and even earlier. Checking his Appendix B, which gives the "Funding Ratio Ranking by System", I found that of the top 17 ranked systems, UCRP was the only one whose valuation date was actually 6/30/02, the nominal date of Wilshire's comparison. This makes a big difference because, with the steep decline in the stock market over the past 3 years, invested assets looked a lot bigger in 2000 and 2001 than in 2002. I am at a loss to explain Nesbitt's gross misinterpretation of his own data.
To make a proper comparison, I needed to get copies of the Wilshire report from previous years. I was able to find only their 2002 compilation on the internet; and, although I wrote to the UC officials who ought to be knowledgable about this subject, they have not provided me with any further information. So, on the basis of this limited data set, I conclude that: a true ranking of state retirement systems by Funding Ratio (at comparable valuation dates) shows that UCRP is #1 in the country, by a substantial margin, and has held that position for at least a few years.
This finding leads me to ask two questions:
What is the source of that outstanding position? and, What can we expect
of the near future? Using UC's published data, I have drawn the graph
displayed in Figure 1, below, which shows the last ten years' evolution
of UCRP's Assets and Liabilities. These are the same definitions
as used by Wilshire (market value of assets and actuarial accrued
We see that from 1994 through 2000 the excess of UCRP assets over
grew enormously, reaching a maximum surplus of over $18 billion.
Then, the last few years shows a rapid decline, with the two curves about
to cross any day now.
One should not panic; there is no imminent threat to my monthly retirement check. The liability calculation looks at all future obligations of the pension fund while this asset number is merely the current market value. An alternative calculation carried out by UC's actuary uses instead the "Actuarial Value of Assets", which is a five-year average of market values and looks less volatile. Nevertheless, it seems that the regents will soon be facing the necessity of resuming payments into the pension fund, something they had been able to suspend a dozen years ago. That money would probably come from employees' paychecks and/or from state appropriations.
Still, the picture shown in Figure 1 begs for interpretation. The superficial explanation of this history is: the stock market went up and then the stock market went down. But this explanation is inadequate on both sides. Before the bubble burst, everybody rode up with the bull market; but, as noted above, UCRP did significantly better than comparable pension funds. Therefore, some extra measure of credit is due to the investment skill of the UC Treasurer's Office in that period (before Wilshire).
What about after the bubble burst, should Wilshire be blamed for at least some part of the very rapid decline? Earlier analyses of mine (see especially Part 11 of this series) pointed out a variety of errors that Wilshire made in designing the regents' new asset allocation policy in 2000. This latest data, in Figure 1, certainly shows that Wilshire has failed in their primary mandate, which was to preserve the surplus that had been accumulated in UCRP.
C. Real Estate Investments
From the March 4, 2003 meeting of the regents Committee on Investments:
Regent Gerald Parsky: "Next is a discussion of real estate investment strategies. Just by way of introduction: our asset allocation plan and the policies adopted by the regents do not include the investment in real estate by either in a direct basis or through funds. This is an area that the staff and its consultants have raised as something that they would like us to consider. ..."
.... [presentation by the UC Treasurer's staff] ....
Regent Richard Blum: "Gerry, This is Dick. What is the strategy here? Is this something where we are going to ask Wilshire to help find us real estate managers or is this a process that we're, God forbid, talking about doing in-house? Just what is the plan?"
Parsky: "Your adjectives suggest your point of view. I know that"
.... [presentation from CalPERS people on their real estate investment program] ....
Parsky: "Before we move on, any questions in the public session?" ...
Blum: "Gerry, this is Dick. I just think that CalPERS has the ability and demonstrated it to have large enough staff in-house to invest wisely and keep track of this stuff. I don't think we can do it for the University on our own, so that we need to either farm this out to advisors who can tell us who we want to place our money with, and/or work out something with CalPERS."
Parsky: "Those two things, Dick, are exactly what we are thinking about." ...
Why do I dwell on Regent Richard Blum's pointed comments? The San Francisco Chronicle published a story, on February 19, 2003, headed, "Real estate giant grows, CB Richard Ellis to acquire big competitor", and they reported:
"The deal, rumored for months amid a sagging commercial market nationwide, would create the largest real estate services company in the world. ... The buyout would also make San Francisco financier Richard Blum, whose Blum Capital Partners is already the controlling interest in privately held CB Richard Ellis, chairman of the new entity."
At their April 22 meeting, the regents' Committee on Investments gave formal approval to committing 5% of UC's investment capital to real estate, both in public funds (REITs) and in private partnerships. I don't know whether or not this is a good idea; however I thought some of the quantitative analysis presented by Treasurer Russ appeared weak. His basic argument is that diversification of the investment portfolio is a good thing; and one slide showed how the Sharpe Ratio for UCRP, which measures in at .34 without a real estate component, would increase to .35 with that addition. I wondered if that represented a significant improvement or just a marginal or dubious move; but nobody at the regents' table asked such a question. In another slide Russ showed how the addition of real estate to the asset allocation would move the UCRP portfolio closer to "the efficient frontier", a standard concept in modern portfolio management. However, the improvement he showed appeared so small that I again wondered if it was at all significant. This time, one of the regents did ask a question but got a rambling and pointless response from the Treasurer.
One topic that did not get discussed at all (in the regents' open session) was about the magnitude of fees that would be paid to outside real estate investment managers. Again, I have no knowledge of my own on this business; but I have looked at CalPERS' published experience as a guide. Readers may recall that my earlier critiques of the plan for outside management of UC's stock investments included the observation that CalPERS (the nation's largest public pension fund) pays something like 1% of assets to outside managers; and I thought that was a very large figure. Well, for its real estate program, CalPERS pays an even larger set of fees - averaging around 8% of assets invested - to outside real estate companies for a variety of services.
Conclusion: while this venture into the real estate market may or may not pay off for UC, it will certainly be welcomed by the commercial real estate industry, which the Chronicle observed to be in the midst of a "sagging" market.
D. More on Risk-Adusted Returns
In Part 17 of this series I showed a graph which contrasted the UC Treasurer's analysis of UC's internal equity investment performance (bare returns relative to benchmark over 10 years) to a more informed "risk-adjusted" analysis of the same data. At their April 22 meeting, the regents' Committee on Investments got an updated presentation from me (3 minutes in the Public Comment Period) which showed even more clearly that they had "killed the goose that layed the golden egg" when they decided to fire their equity investment staff. I admonished the regents to not ignore this issue but to investigate and find out how they had been so misguided.
Uncharacteristically, this got some response from the regents' own experts during the open portion of their meeting. First it came from Bruce Lehmann, a Professor of Economics and Finance at UC San Diego, who serves as a consultant to the regents' Investment Advisory Committee.
Lehmann: I would also add one thing. That is that the benchmark that was used in Professor Schwartz' study is the S&P 500. And the benchmark that has been adopted for the equity portion of the retirement system is the Russell 3000, which includes many smaller stocks. ...
Treasurer David Russ; I just want to point out that there was a change in this benchmark in 2000. So prior to 2000, the benchmark that we use is the S&P 500, after that it's the Russell 3000.
Professor Lehmann was wrong in his criticism of my calculations and Treasurer Russ was very decent to correct him on the issue of what benchmark should be used. Russ is familiar with the data which I used in my calculations since I got that data only after persistent requests to his office. (I would venture to guess that Mr. Russ has actually carried out his own calculations of the risk-adjusted returns: he has all the data at hand and his staff is competent to do the calculations; and certainly I have been hounding him for months about his earlier failure to do this. If he had gotten results which contradicted mine, I am sure he would have said so.)
Some time later in the meeting it happened again, this time with the Wilshire consultant playing hatchetman:
Parsky: "We have said that on the management of public equities, the Russell 3000 is the tolerance level [for risk], if you will, that we are willing to maintain, for the equity portion of this. Steve."
Steve Nesbitt: "And that is really the flaw in Professor Schwartz' analysis because his risk adjustment ignores the benchmark of the Regents and prior to 2000, the Treasurer's benchmark. His assessment of risk is not the same as the Regents' assessment of risk and so his risk adjustment is in error."
Russ: "Rather than talking about that, ..."