What’s Happening with the Pension
Fund? -- Part 21
by Charles Schwartz, Professor Emeritus, University of California, Berkeley
firstname.lastname@example.org March 28, 2004
>> This series is available on the Internet at http://ocf.berkeley.edu/~schwrtz
New Documents Reveal Wilshire’s Con
A huge pile of documents were released following the
lawsuit against the Regents over excessive secrecy in their investment
activities. We can now see a clear pattern of duplicity by Wilshire
Associates, with assists from some UC officials, in busting up the
successful staff of the former Treasurer and moving billions into the
hands of external investment managers.
The main issue studied here is how UC’s
investment consultant Wilshire Associates (with later assists from
Treasurer David Russ) went about evaluating the past investment
performance of the UC Treasurer’s office, mostly regarding the common
stock portfolio of the retirement and endowment funds. The standard
calculations for a professional evaluation answer the following
•How do the past investment Returns, over various periods of years, compare to those of a designated Benchmark?We shall see that Wilshire misrepresented one of these criteria (Risk measurement), completely ignored another (Risk-Adjusted Returns), fabricated another (the appropriate Benchmark), and played switcheroo on the last (choice of a Peer Group).
•How does the Risk (measured as the standard deviation of returns) compare to that of the Benchmark?
•How does the Risk-Adjusted Return (combining these two sets of data) compare to the Benchmark?
•How do these performance data rank compared to a relevant Peer Group?
A 10-page document from Wilshire Associates, “University of California; Total Fund Analysis; June 30, 1999”, appears to be their first technical report after being hired by the Regents to review UC’s investment operations. It starts with data on “Total Fund Universe Rankings.” The comparison “universe” they used is identified as “26 defined benefit [pension] plans with assets in excess of $10 billion, including 19 public funds and 7 corporate funds.” For the last 3-year period, UC ranked #2, with annualized Return 2.80% above the median; and for the last 5-year period (the longest covered by Wilshire), UC ranked #1, with annualized Return 4.61% above the median. WOW!
The second page shows the results of
Wilshire’s “Total Fund Risk Analysis.” Here we learn that, for the five
years ending 6/30/99, UC’s total investment portfolio showed a level of
Risk which was less (better) than the median (rank 38th percentile) at
the same time that its annualized Return ranked at the very top of this
universe. This, I think, says that UC’s outstanding performance should
not be ascribed simply to luck.
Subsequent pages of this report analyze separately the US Equity (stocks) and US Fixed Income (bonds) in the UC portfolio. The following are Wilshire’s numbers for the 5 year period. The UC Returns on Equity ranked at the 29th percentile of the peer group (almost in the top quartile), while the Risk for this portion was significantly lower than all of the peers (rank #1.) They also compare UC’s Equity performance to that of the Wilshire 5000 index: the Returns were almost identical while the UC Risk was much lower. For the UC Fixed Income investments, the Return was far ahead of all others in the peer group (rank #1), as well as far ahead of the Lehman Aggregate, which is shown for comparison; the Risk measurement here exceeded all the others’ (rank last.)
This first report from Wilshire is a collection of numerical data, in tables and graphs, with explanatory footnotes; it is identified as the output of “Wilshire Compass”, the software database and analyzer developed by the company for their own and clients’ use. For a discussion of these results, along with Wilshire’s recommendations, we must turn to a separate document, “Review of the UC Treasurer’s Office Investment Program - Executive Summary, July 7, 1999.” Here we find quite a different story: “Total portfolio returns versus university peers is good, but misleading when used as a guide to evaluate the Treasurer’s investment program.” They describe both the stock and bond portfolios as having serious “risk factors”; and they repeatedly emphasize that the stock portfolio “has consistently under-performed the S&P 500 Index”, which they call its “benchmark.” We shall investigate these claims closely.
Lets dig into this question of what
benchmark to use in studying UC’s past equity performance. The first
Wilshire report did not mention the S&P 500 index at all; it only
used the Wilshire 5000 Index for comparison (in addition to the peer
group) and did not mention the word “benchmark.” I find a nice
definition of this concept given by Wilshire’s own Stephen Nesbitt
during the October 29, 2002 closed meeting of the Regents’ Committee on
Investments (transcript released following out lawsuit: page 11.)
MR. NESBITT: I’m the honest broker. I work for you. I don’t work for the treasurer. And when you first hired us three-and-a-half, four years ago, when we did this analysis, we came to this conclusion [to outsource equity investments] back then.
For example, the reason you have an index fund representing 30% of your equity component, that was our recommendation because basically when we did the analysis back to 1983, and we saw the equity performance wasn’t good, our initial recommendation was for much more index. But we brokered a compromise and came up with 30%.
One problem three-and-a-half years ago in trying to critique the treasurer’s performance is that you - the Regents had no policies. So, in essence we could not hold the treasurer or staff truly accountable because you had no policies.
We all agree on some policies and then we can measure you against those policies. And then there can be no argument about what your objectives are.
The performance of each actively-managed asset class should be measured by an index which represents its passively-managed alternative. ... In other words, the Regents’ portfolios will not always “track” the chosen benchmark index as would a manager who is being paid to match a particular index’s sector weightings and portfolio characteristics. ... Typically, the Regents’ equity portfolios consist of large capitalization securities somewhat similar to the broad market as measured by the S&P 500 [index]. ... Over the long term, the common stock portfolios have slightly trailed the S&P 500.Thus, while the explicit “benchmark” established for evaluating performance of the UC Treasurer’s common stock portfolio was clearly the SEI peer group Median, a reader may conclude that the S&P 500 index also played a role for comparison purposes. It is entirely illegitimate, however, to assert - as Wilshire did without qualification or justification, in 1999 and thereafter - that the S&P 500 index is the benchmark by which to evaluate the past performance of the UC Treasurer’s domestic equity investments. One can redefine the benchmark for future reference, as the regents did in 2000 following Wilshire’s recommendation (adopting the Russell 3000 index for equities); but it is grossly dishonest to rewrite history as they have done. I raised this subject as a question in earlier reports and the new documents provide the answer: Wilshire fabricated this story of the S&P 500 as UC’s “historical benchmark” and, with help from Treasurer Russ, they got the regents to buy it.
Fudging the Evaluation of Portfolio Risk
We noted that the June 30,1999 Wilshire
Compass analysis of UC’s investments showed a quantitative measure of
Risk in the stock portfolio which was outstanding: well below the
market index and well below all other members of the peer group.
However, in Wilshire’s July 7,1999 Executive Summary this data is not
mentioned at all; and a completely different discussion of Risk is
[C]lose examination of the UC total portfolio reveals that it is unusual in composition and potentially very risky. The UC stock portfolio is concentrated in 65 large U.S. growth stocks with the largest 10 holdings representing almost 40% of the stock portfolio. This portfolio profile is very different from most large pension and endowment stock portfolios that are diversified into medium and smaller sized U.S. companies, and international stocks.
Looking at Risk and Return Together
Even if we allow Wilshire to use the
S&P 500 as a benchmark for measuring the past UC equity
performance, there is a major roadblock to reaching the conclusion they
do. This is the fact that while UC’s Returns over 10 years lag by about
1% per year - and this is the main argument used by Russ and Wilshire
in the fall of 2002 - the UC stock portfolio shows a significantly
lower Risk than the S&P 500. The correct way to balance these two
factors (Was the lower return adequately justified by the lower risk?)
is to calculate what are called “risk-adjusted returns”. This well
established professional method is not mentioned anywhere in these
Wilshire reports or in any of the newly released documents. In my
earlier reports (see Parts 13-18 of this series) I pointed out this
failure and did my own calculations, using official data from UC, with
a resulting conclusion that was exactly the opposite of what Wilshire
and Russ said.
Was this a case of deliberate distortion/hiding of facts or might one imagine that Wilshire had some reason for not using such risk-adjusted calculations? A visit to Wilshire’s website and a display of their “Compass” program showed that they do indeed use risk-adjusted calculations - in the form of “Sharpe ratios” - and a look at the UC Equity Risk/Return graph in Wilshire’s June 30, 1999 report shows that UC’s Sharpe’s Ratio beats all the others (rank #1). One is thus led to believe that they did this calculation, saw the results, and decided to keep it quiet.
The 87th Percentile Ranking
When the regents’ Committee on Investments
met on October 29, 2002 to consider the proposal that all of UC’s
equity investments should be given over to outside managers, one of the
most damning “proofs” of poor performance by UC’s internal equity
investment staff was a new comparison with peers, prepared by Wilshire
and presented by Treasurer Russ. We read from pages 5-6 of the
transcript of that closed meeting:
TREASURER RUSS: This chart, we’re on Page 4, shows the internal portfolio ... relative to the universe of large capitalization equity managers. ... That’s the other managers that manage in the U.S. equity arena. If you look at the far right, under 10-year, 10.34, 87 means 87th tile. Eighty-seven out of a hundred. And you can see for the 10 year, it’s at the bottom.
|Top Quartile (25)
|Bottom Quartile (75)
|UCRP UC Treasurer
||10.34 (87) <-----
|# of Managers in Ranking
|CRA Equity Only Median *
|Large Cap Core Funds
The $4.8 Billion Fracas
The most outrageous example of cheap tricks
in this now revealed saga, is provided by Regent John Moores, Chairman
of the Board (and a well known investor from San Diego.) At the October
29 meeting, after Treasurer Russ had made his presentation showing that
UC’s internal equity investments, over a decade or more, had trailed
the benchmark by about 1% per year, we read, (starting on page 8 of the
REGENT MOORES: What do they look like cumulative...That was not the number Moores had asked for: he wanted to know how many dollars that shortfall amounted to. However, when it came to the November 13 meeting - when the Investment Committee recommendation was brought up for approval by the entire Board - Moores had his ducks all lined up. From the Minutes:
TREASURER RUSS: We’re only showing the 10-year return here, but ...
REGENT MOORES: I meant the dollars. I just was curious about the dollars.
TREASURER RUSS: Well, we’d have to calculate that.
REGENT PARSKY: Why don’t you get it for John?
TREASURER RUSS: I’m not going to run a number off the top of my head on that.
REGENT MOORES: I’ll bet you can come close.
TREASURER RUSS: We can get a number, yes. ... [skip to page 13]
TREASURER RUSS: I have an answer to Regent Moores’ question. Dennis Sugino [from Wilshire] just handed me this. This just in. From the inception date of 12/31/83 to 9/02, the return on the equity portfolio ... is 11.01%. The policy index, 12.02. ... So 101 basis points.
Chairman Moores praised the efforts of Regents Hopkinson and Parsky in revamping the University’s investment policies. He asked Treasurer Russ how many additional dollars would be in the University’s coffers if its funds had merely met the benchmark. Treasurer Russ reported that he and Auditor Reed had calculated a figure of $2,5 billion over the ten-year period. If they had been managed by outside professionals, another $2.3 billion might be added to that figure.
Another Old Issue Clarified
In my earliest paper in this series I
criticized Wilshire’s March 16, 2000 Investment Strategy Study for its
misleading presentation of data projecting future assets and
liabilities for the pension plan, under alternative investment
policies. My complaint was that a prediction of future quantities must
be probabilistic and should be shown with the large uncertainties of
such mathematical exercises, while Wilshire made it look like these
were true numbers. What we learn now from the release of the minutes of
those closed regents’ meetings is that this misleading data did indeed
play a central role in convincing the Board to follow Wilshire’s
Wilshire’s dishonest campaign to get the
money out of UC and into the hands of commercial investment managers,
which I speculated on in my early reports, has now been confirmed by a
wealth of new evidence. Earlier, it was difficult to provide a motive
for this; but with recent revelations about the multitude of kickback
schemes in the investment and investment consulting industry, that
question seems answered.
Finally, what blame falls to members of the UC Board of Regents? One or more were doubtless involved in the plot; it is likely that some others were biased toward the outcome (privatization); and most were merely dupes in the hands of slick pros. They all had opportunities to ask questions (they didn’t have to believe me in order to ask questions raised in my reports, which they all received). Yet they all failed, as far as the present records show, to exercise that minimum standard of responsibility.