by Charles Schwartz, Professor Emeritus, University of California, Berkeley
firstname.lastname@example.org October 16, 2000
>> This series is available on the Internet at http://ocf.berkeley.edu/~schwrtz
Contents of the Series
Part 1 - Introduction; Digging into the Wilshire Report
Part 2 - Further Problems with Wilshire's Study for the UC Regents
Part 3 - a) Unwarranted Secrecy in the Regents' Doings
- b) Trying to Evaluate the UC Treasurer's Performance
Unwarranted Secrecy in The Regents' Doings
Here is a concise history of this affair, taken from the Regents' Joint Statement of July 19, 2000 (previously cited in Part 1):
"The University of California Board of Regents has a fiduciary responsibility to exercise an oversight function of the university's investment activities. ... A comprehensive review of the university's investment policies and procedures was begun in late 1998. The review process included input from the Treasurer's Office and involved members of the Regents Investment Committee, outside experts who were on the Commission, and the Wilshire firm, took one and one-half years and culminated in adoption of a comprehensive asset allocation plan by the Board of Regents which updated previous asset allocation determinations made by the Regents."And all of that deliberation was conducted behind closed doors.
When I wrote to UC President Atkinson on July 27, asking for copies of all documents that would help me understand what was happening with the regents' changes in investment policies (see the text of my letter in Part 1), I knew about the California Public Records Act, which would require them to take this request seriously. Some days later, I received a letter from the General Counsel's office which said that my request for documents was "quite broad" and indicated that some documents I had requested might be "privileged". I wrote back, trying to narrow my inquiry to the topic of "the University's investment policies and performance," and I made a specific request for copies of the Minutes of regents' meetings concerned with this topic.
Finally, on September 11, documents had been
collected, reviewed by the General Counsel, and I was offered a collection
of over 400 pages. There is some interesting material here, which
I plan to use in later installments of this series. But the Minutes
of regents' meetings, which I had specifically requested, were withheld
as "privileged" documents. I then wrote a formal appeal to
President Atkinson (dated 9/13/00) and also presented this letter to the
Board of Regents at their September 14 meeting. I'll reproduce most
of it here.
Let me quote from California's Open Meeting
Law (Gov. Code Sec. 11120):
"In enacting this article the Legislature finds and declares that it is the intent of the law that actions of state agencies be taken openly and that their deliberations be conducted openly. The people of this state do not yield their sovereignty to the agencies which serve them. The people, in delegating authority, do not give their public servants the right to decide what is good for the people to know and what is not good for them to know. The people insist on remaining informed so that they may retain control over the instruments they have created."
Aside from whether it was proper to hold those previous closed meetings on investment policy, we now face the question of whether the Minutes of those meetings ought to be kept secret. It is my view that the public interest is better served by making those Minutes public. And California Government Code Section 6255 places the obligation of justifying the contrary view upon the agency that withholds the documents.
Aside from legal arguments, the Regents should consider their fundamental role as trustees - especially relating to their responsibilities over the pension funds, endowment funds and other University funds. We are all aware that there has been considerable public noise over the recent changes in investment activities of The Regents. Several public statements have been issued trying to reassure members of the public, and especially employees of the University, that all their money is safe and that everything has been handled in a wise manner. It should be clear that further concealment of documents that ought to be made public will only exacerbate the sense of unease and distrust that now exists.
Please let me hear from you as soon as possible.
There has been no response at all to this appeal - just as several other letters of inquiry on this subject have gone unanswered by UC's top officials. This tactic is called stonewalling; and one can guess, though not admire, the motives that lead to such un-academic behavior.
Let me say directly why it is important to see those Minutes, especially of the meetings in January and in March of this year when Wilshire Associates presented their Study to the regents. In Parts 1 and 2 of this series of papers I have made very serious criticisms of what I found in the Wilshire report and concluded with the question of how The Regents could have bought such a lousy piece of work from a presumably expert consulting firm. To illuminate this question, one needs to see the character of the dialogue, the questions and comments by members of the Board of Regents when Wilshire made its presentations to the Committee on Investments.
It is not just the regents themselves whose
competence and attention to duty is brought into question by these circumstances,
but also that of their advisors - the University's Chancellors and Vice
Presidents and other high administrative personnel - who were present at
those closed meetings. It would be appalling if nobody asked the
Wilshire people, "How significant is that small difference between Policy
C and Policy D," or if nobody asked about the meaning and the implications
of "standard deviation" in their forecasts of investment returns.
And, assuming such basic questions were asked, I would like to see how
they were answered.
Trying to Evaluate the UC Treasurer's Performance
In Part 2, I ended by noting that UC's hired consultants, Wilshire Associates, had - as far as one can see from their official report to The Regents - simply ignored the question of evaluating the past performance of the UC Treasurer's office in managing the investment of $53 Billions over the past years. Neither did they consider alternatives to their own recommended policy changes in an objective manner.
In Table 1 is a set of data that shows how
well the UC Treasurer has performed over the past 1, 5, 10, 15, 20-year
periods, compared to standard market indicators. The Benchmark used
here is 65% S&P 500 index + 35% Lehman LT Gov/Corp index.
This benchmark reflects the stock/bond division within these UC portfolios;
and it also reflects the UC emphasis on large cap stocks and long term
bonds. (This data may be found at www.ucop.edu/treasurer/returns.html
|UCRP (pension fund)||12.8%||18.7%||15.6%||15.7%||15.7%|
|GEP (endowment fund)||14.7||19.5||16.0||16.1||16.2|
In assessing the data shown in Table 1 we should ignore the 1-year numbers, which can fluctuate quite a bit from year to year, and concentrate on the longer term averages. We see that the UCRP (UC Retirement Plan) outperformed the benchmark by (0.8%, 0.7%, 0.4%, 0.3%) for the 5-, 10-, 15-, 20- year periods, respectively. These are significant differences. (Remember that Wilshire Associates based their recommendation of Policy C over Policy D on 0.2% difference in expected return.) We also see that the GEP (General Endowment Pool) outperformed the benchmark by even larger margins, (1.6%, 1.1%, 0.8%, 0.8%).
Another document, prepared by the UC Treasurer's
Office, gives comparisons of Risk-Adjusted Common Stock Performance, compared
to several leading market indices. See Table 2.
|Wilshire 5000||Russell 3000||Russell 1000||S&P 500|
While the Wilshire report dismissed UC's excellent investment performance in past years, by crediting this to the "15 year bull market", the above comparisons are more telling, since the benchmark returns have also benefitted from that same bull market. What the numbers in Tables 1 and 2 tell me is that the UC Treasurer's investment strategy (well informed stock-picking) has consistently and significantly outperformed the major index funds. Why, then, one asks, did the regents decide to throw away that proven advantage and go with Wilshire's preference for index funds? I expect that there are experts who will disagree with this conclusion and I hope to hear from them.
The next, and more difficult, question in comparing the UC Treasurer's investment strategy with that of the index funds' proponents is this: What can we say about forecasting future returns? I note that the Wilshire report (on page 6) talks about how they make their long-term return and risk forecasts: "the past return history of the different markets is evaluated. But current market conditions are also weighed in the forecast." The data in Table 1 show that as one moves to more current data (the shorter term numbers) the comparative advantage of UC's investment strategy over that of the benchmark gets much larger! This argues in favor of maintaining the previous UC investment strategy rather than switching to an emphasis on index funds.
Another comparison, which I barely began in
Part 2, looks at the past performance of UCRP and PERS (California Public
Employees Retirement System), which has been following Wilshire's investment
advice since the mid-1980s. This is useful because it lets us talk
about risk as well as return numbers. I have found reliable data
on annual returns over the past 17 years for PERS (www.calpers.ca.gov
Investment Facts, September 2000) and for UCRP (from annual reports found
in the campus library.) I can use these data to calculate the average
and the standard deviation of returns; but there is a technical difficulty
because Wilshire never informs us about what mathematics they use.
Table 3. Shows my results with two different methods of calculating the
average and standard deviation (S.D.) - one method works directly on the
returns, the other method uses the logarithm of 1+ return.
|Method 1||Method 2|
|Average||S. D.||Average||S. D.|
What we see in Table 3, by either method of calculation, is that UCRP has had substantially greater average returns (by over 2%) and also substantially greater standard deviation - i.e., risk - (by over 3%) when compared to PERS. A judgment between these two is therefore not simple. I will, nevertheless, make one attempt at a quantitative analysis, following the general line of work given in the Wilshire report.
The task is to make future projections of UCRP growth, using alternative investment strategies, and see which does better at meeting the pension plan's long-term obligations. The Wilshire study, as discussed in Part 1, uses the numbers for their Policy C: Expected Return = 8.5%, Expected Risk = 12.3%. We note that these (future) numbers show much lower returns and much higher risks than the (past) numbers for PERS shown in Table 3. This represents Wilshire's informed guess as to how much different the financial markets are going to behave in the future, compared with the past. Now I want to compare estimates of future performance for UC-style investment strategy with those of PERS/Wilshire-style investment strategy. So I will take the "Difference" numbers from Table 3 and add them to the Wilshire numbers for expected future behavior. That is, I will calculate UCRP futures using the input data:
|Year||Average||S. D.||Probability of Meeting Plan Liabilities|
|2010||100||51||83% (Wilshire gave 78%)|
|2020||242||179||73% (Wilshire gave 58%)|
|2029||534||500||70% (Wilshire gave 49%)|
The net result of UC-style investment strategy, with its higher expected returns and higher expected risk, appears in the last column of Table 4: Much higher probabilities of meeting the retirement plan's future obligations (without any further payments into the fund) when compared to Wilshire-style investment strategy! (The results using Method 1 enlarge this advantage, by 2 to 4 percentage points.)
Again, I expect experts will be able to criticize this calculation. Please do. I have been bold in venturing beyond my own expertise because I wanted to illustrate, once again, the sort of objective analysis and comparison of alternative investment strategies that should have been included in the consultant's report to The Regents.
Conclusions to Part 3
The regents ought to release all the background
documents related to their change in investment policy - especially the
Minutes of their meetings dealing with the Wilshire Investment Strategy
Study. Those documents, when opened, may also shed some light on
why the outstanding past performance of the UC Treasurer has been so neglected
in the regents' choice to go with Wilshire's preference for index funds.