What's Happening with the Pension Fund? -- Part 5

by Charles Schwartz, Professor Emeritus, University of California, Berkeley
schwartz@physics.berkeley.edu                         October 30, 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
Part 4 - Questions on Safety of the Fund; Diversification; Oversight
Part 5 - Privatization; Private Equity Investments; Conflicts of Interest

Words and Action on September 14

     When the Regents met on Sepetember 14 in San Francisco, the open session began with the usual Public Comment Period.  There were two speakers.

Mary Higgins:  "This morning I am an official designate of CUE, which is the Coalition of University Employees, an independent union that represents...  We are the clericals, the eighteen thousand clericals here. And I've been asked to make a statement, notwithstanding that we appreciate that our treasurer met with Regent Hopkinson earlier this week.  I want to make the following statement.
     "The decision to change the way our pension funds are handled was made and implemented without sufficient public notification and discussion and to this we are opposed.  We also oppose the privatization involved in this new way of doing business and are further concerned that there is a political bias and benefit of which we do not approve.  Thank you. "

I was the second speaker, also on the subject of UC investment policy.  Then the Chairman of the Board delivered a prepared statement. (These quotations are transcribed from the Secretary's tape recording.)

Regent S. Sue Johnson: "If the Board will grant me a point of personal privilege, I would like this morning to take a rather unprecedented step of responding briefly to the comments that the speakers have made about our recent investment policy changes.   First let me say strongly and clearly from the outset, the continued safety and healthly performance of the university's pension fund is the Board's highest priority.  The Regents have the fiduciary responsibility for overseeing the assets and investment of these funds.  Throughout the nearly two year process in which the University's investment policies and procedures have been under review, each and every regent has had the best interests of the university and its current and former employees, and only those interests, [at] heart in its deliberation.
     "Now as regarding concerns about the review process - [that it was] secretive and/or politically motivated.  The Regents acted in accordance with the state's open meeting laws and established university procedures.  Its finding are a matter of public record.  Furthermore, employees and members of the public can read in great detail the reports and a summary of the review process and the new investment policies on the Office of the President's web site.  The new policies and practices are based on sound financial grounds.  No political pressure or personal gain was involved at any stage of the process.
     "And, finally, if I may, regarding the "privatization" of the pension fund.  The University of California is not, I repeat not, about to privatize these funds.  That was not and is not an objective of the nearly two year review of the University's investment policies and management structure.  The University will maintain their custody over these funds and assets and their responsibility for their investment."

     The very next topic on the Regents' agenda that morning was, mirabile dictu,

Committee on Investments, Item for Action RE-26.  Selection of Index Investment Manager:  Presentations by Barclays Global Investors, State Street Global Advisors.
Within the hour, the regents considered and then decided which one of these two firms (it was State Street) would be given $11,550,000,000  from the accounts of the University, which would be put into their privately managed index funds.  This transfer followed the recommendations of Wilshire Associates - $8.3 billion for the U.S. index fund and $3.25 billion for the non-U.S. index fund - and Wilshire's Steve Nesbitt was there to guide the regents in this decision.

     Oh, but this cannot be "privatization" because the Chairman of the Board of Regents had just assured everyone that "The University of California is not, I repeat not, about to privatize these funds."


     This word means the transfer of some property or of some service from the public realm (government ownership or government function) into the realm of private enterprise.  Privatization is a topic of continual controversy.  Many people think that the recent deregulation of industry and dismantling of the welfare state in many countries (forms of privatization) have been wonderful things in the development of the New Global Economy.  Many people think that the rapid dismantling of government assets in the former Soviet Union (also privatization) was a terrible thing.  There is considerable controversy in this country right now over "school vouchers" - another form of privatization.  It is always a political subject.

     Some people have philosophical or political leanings that make them generally in favor of privatization; others tend to lean against it.  Some may be clear in their understanding of what privatization is all about; others may be unclear but still biased.

     I need this framework in order to present my theory on how The Regents came to adopt the "Investment Strategy Study" by Wilshire Associates - a "really crappy" piece of work - as the new policy for the University of California.

     The easiest explanation is that the regents are just a bunch of fools who don't know what they are doing. (This is a common opinion among faculty, whatever the issue may be.)  I have been to many regents' meetings and heard the phrases "fiduciary responsibility" and "due diligence" recited by members of the board, almost as a mantra.  But I do not believe that they are all, or even mostly, incompetent fools; and so I seek a better understanding of how they could have come to adopt the Wilshire report with all its outragious flaws.  This involves speculation (theorizing), which I undertake now because further sources of reliable information have been denied me.

     Probably a few of the regents felt that they had no expertise in investment matters and so they relied upon the judgment and advice of their more sophisticated fellow regents. I do not think this is an adequate excuse (nor an adequate exercize of due diligence) since, as I have written, there are many points where common sense inquiries could have unmasked Wilshire's false claims.

     Perhaps many of the regents were awed by the aura of "rocket science", which Wilshire uses to promote itself (see www.wilshire.com).  Again, an inadequate excuse.

     Finally, I come to consider possible biases, conscious or subconscious, affecting how individuals on the Board might view the topic of UC's investment policies.  Here is where the issue of privatization comes in.  If one doesn't pay much attention to the substance of Wilshire's study and analysis but just looks at their recommendations, what stands out clearly is the fact that substantial amounts of what was formerly held and managed by the public Office of the Treasurer would be moved into the private sector.  If one is inclined (biased) in favor of privatization - the general idea that private enterprise is superior to other forms of organized activity, especially when lots of money is involved - then Wilshire's recommendations are innately attractive.

The Players

Members of the Regents Committee on Investments - March, 2000

  • Gerald L. Parsky (Chair of the Committee) - appointed to the Board by Gov. Wilson in 1996; member of the Committee since 1996.
  • Peter Taylor (Vice-Chair) - Alumni representative on the Board for one-year term.
  • William T. Bagley - appointed by Gov. Deukmejian in 1989 and 1990; member of the Committee since 1990.
  • S. Stephen Nakashima - appointed by Gov. Deukmejian in 1989 and by Gov. Wilson in 1992; member of the Committee most years since 1990.
  • Howard H. Leach - appointed by Gov. Deukmejian in 1990; member of the Committee most years since 1990.
  • David S. Lee - appointed by Gov. Wilson in 1994; member of the Committee since 1996.
  • Judith L. Hopkinson - appointed by Gov. Davis in 1999; member of the Committee since 1999.
  • Sherry L. Lansing - appointed by Gov. Davis in 1999; member of the Committee since 1999.
  • John J. Moores - appointed by Gov. Davis in 1999; member of the Committee since 1999.
  • Gray Davis - Governor of California, ex-officio member of the Committee.
  • John G. Davies - Chairman of the Board, ex-officio member of the Committee; appointed by Gov. Wilson in 1992; member of the Committee since 1993.
  • Richard C. Atkinson - President of the University, ex-officio member of the Committee; President since 1995; previously Chancellor at UC San Diego 1980-95.
  • Subsequently,  as of July 1, 2000:

  • S. Sue Johnson became Chairman of the Board of Regents; appointed by Gov. Deukmejian in 1990; no previous service on the Committee on Investments.
  • Judith L. Hopkinson became Chair of the Committee on Investments.


         Regent Gerald Parsky has been the leader throughout this adventure.  He was Chair of the Regents Committee on Investments for the past two years, Chairman of the special Commission to Review the Office of the Treasurer, and is now Chairman of the newly established Investment Advisory Committee.

         Several regents listed above have careers in high finance - Regents Hopkinson, Leach, Moores, Parsky, Taylor - and a number of other regents are also very experienced in the world of business and/or enjoy great personal wealth and so can be presumed to be sophisticated on the subject of financial investments.

         In order to get to the next level of possible biases among the regents, we need to examine an area of Wilshire's recommendations not yet discussed in these papers.

    Private Equity Investments

         Wilshire recommended that UC increase its allocation of investments to Private Equity (venture capital and buyouts) from 2% to 5% in both the pension fund and the endowment fund.  This asset class offers higher expected returns - Wilshire gives 11.75% expected return for Private Equity compared to 8.75% for ordinary stocks - and it also poses higher levels of risk - Callan gives 36.0% expected risk for Alternative Investments compared to 16.3% expected risk for broad domestic equity.

         The following background information is taken from a March 1999 paper by the UC Treasurer's Office, "Private Equity Review", which is among the documents provided in response to my Public Records Act request.

  • UC began investing in venture capital funds in 1979 and committed $458 million through 50 partnerships, giving a return (net IRR) of 21.2% through 12/98.
  • UC has been investing in subordinated debt funds since 1986 and in buyout funds since 1987, with a total of $561 million committed through 13 partnerships; the returns (net IRR) through 12/98 were 15.9% and 27.6%, respectively.
  • The Office of the Treasurer, which has managed this portfolio since its inception and has successfully selected premier private equity managers, is recommending an expansion of the private equity program over the next decade.  This expansion would entail: (i) increasing the target allocation range for private equity to 4%-6% of the Regents' portfolios; and (ii) expanding the types of private equity strategies.

  •      An aside:

    Someone mentioned to me that Yale University had embarked on a very ambitious program of investment in private equities and had done very well.  I went to Yale's web site and downloaded their 5-year review (www.yale.edu/search/endowupdate99.pdf).  Their endowment fund had (as of 6/30/99) a 23% allocation to Private Equity investments, with a 10-year annualized return of 28.5%.  Yale's 10-year annualized return on the total endowment portfolio was 14.9%; which one can compare with the UC General Endowment Pool's 16.0% return for the same period.  I also found that the Yale report had a very instructive discussion on the philosophy of investing, comparing active management with index following.  Coincidentally, UC has just hired a new Senior Vice President for Business and Finance - Joseph P. Mullinix - who previously held a similar position at Yale.  It appears that he will play a significant role in managing UC's new investment strategy.

       Among the documents given to me in response to my public records request are a series of letters between UC's Treasurer Patricia Small and Gerald Parsky, chair of the Regents Committee on Investments, in which she urged him, and the committee, to consider proposals for expanding the private equity investments.  It seems that Parsky continually delayed or rebuffed such requests, throughout 1999 and into 2000.

        The most interesting document is, "UC Treasurer's Response to the March 16, 2000 Wilshire Investment Strategy Study." This contains a number of cogent critiques of the Wilshire recommendations - all of which seem to have been rejected by the regents.  (Again, I would like to have the Minutes of that Regents meeting and see how these issues were discussed.)   Below is Item 5: Management of Private Markets Portfolio.

    Wilshire recommended that the private markets portfolio be managed by an outside advisor(s).

    UC Treasurer Recommendation: The Treasurer's Office feels that the Venture Capital portion of the Private Equity Portfolio should continue to be managed by the Treasurer's Office and an outside consultant be used to assist in the expansion of the program into buyouts, especially in UCRP.  The reasons are as follows:

  • The Treasurer's Office has successfully managed the private equity program in-house for 20 years, establishing deep institutional knowledge, long-standing relationships and unique access to the private equity market place.  This program has provided The Regents and the beneficiaries of the program with consistent, top-tier returns.
  • Current Venture Capital returns have created a stampede of interest, especially from wealthy individuals attempting to access the top tier Venture Capital funds.  It is very clear from our recent conversations with the top tier venture capitalists as well as our top performing peers, that introducing an outside intermediary would dis-invite The Regents from investing in the top tier VC funds.  Highly sought-after top tier Venture Capitalists have stated clearly that they want to deal only with investment professionals like the Treasurer's Office and not consultants.

  • ...
  • Our public, corporate and endowment/foundations peers who are active in the private equity arena advise that The Regents would be better served by expanding the internal resources of the Treasurer's Office and retaining in-house the investment process, the relationships, the institutional knowledge, and the investment expertise.  Many large institutions are struggling to rebuild their programs after outsourcing and it is those institutions like Stanford, Harvard, MIT and The University of California that have maintained the integrity of their program over time that are generating the top tier returns.

  •      Ignoring this advice, the Regents adopted Wilshire's recommendation that all the private equity investments be channeled through an outside consultant, who would report directly to the Investment Advisory Committee and to The Regents; only those investments recommended by both the consultant and the Treasurer would be considered.

    Conflicts of Interest

         Beyond the broad philosophical bias toward privatization, there are instances where some tangible financial interests may have been a factor. Three regents on the Committee on Investments are themselves in the "private equity" business and this leads me to ask whether there may be conflicts of interest here. (The information below comes from UC's financial disclosure records and other public sources.)

         First is Gerald L. Parsky, chair of the Committee.  He is Chairman of Aurora Capital Partners, a venture capital firm located in Los Angeles.  Following is a description of this company, which I found on the internet.

  • Richard Crowell, Founder and Managing Partner, Aurora Capital Partners

  • Richard Crowell's Aurora Capital Partners matches venture capital with companies--but it doesn't fund the developing high-tech firms that dominate today's headlines. Instead, it consolidates fragmented segments of more traditional industries, combining small companies into new enterprises that can compete successfully in their niches. Since Aurora Capital Partners was established in 1991, it has created eight new companies--with sales totaling $1.8 billion--out of 56 smaller firms in an eclectic mix of industries, from propane gas distribution, to industrial linen, to wax refining. The capital to create these companies has come primarily from institutional investors and pension funds. Through research, Crowell's firm selects industries that are good candidates for consolidation, then develops partnerships with strong managers, identifies and acquires the right small companies, and oversees the consolidation process. Over three to seven years, the companies develop and grow and are then sold or taken public. Since 1994, for example, Aurora has acquired 14 small companies in the automotive transmission remanufacturing industry and created the leading supplier in the market with $550 million in sales. (emphasis added) http://review.ucsc.edu/summer.98/new_faces.html

         Second is Howard H. Leach. He is prominent in California agribusiness and also has major involvements in private equity firms:  he is a partner in Forstmann Little & Co., one of the premier New York buyout firms; he also heads two San Francisco investment companies, Leach Capital Corp. and Leach McMicking & Company.  His financial disclosure form lists many investments, including about 25 that are venture and other forms of capital investment partnerships. The reporting forms show the highest amount of investment as "over $100,000" but it is often the case that private equity investments have a minimum of  $1 million.

         Third is John J. Moores, head of JMI Services Inc. and related privately owned investment companies located in San Diego.  His financial disclosure form lists many investments that appear to be venture capital partnerships; and some SEC records show his holdings to be worth many hundreds of millions of dollars.

         According to state law and University policy, a regent must abstain from participating in the discussion and voting on any matter which might reasonably be thought to have a financial effect on that person or upon an entity with which the person has a business relationship; the regent must specify the nature of the possible financial effect; and this occurrence shall be noted in the minutes of the meeting.  Here is one more reason to see those secret minutes.

         This brings me to the end of this research endeavor, at least for now.  The original questions, "about how and why" the Regents made these changes in the University's investment policies, remain largely unanswered - although I hope this series of papers has provided some useful illumination.  If there are future developments of interest, you should hear from me again.