What’s Happening with the Pension Fund? -- Part 25

by Charles Schwartz, Professor Emeritus, University of California, Berkeley
schwartz@physics.berkeley.edu                                          July 2, 2007
>> This series is available on the Internet at   http://socrates.berkeley.edu/~schwrtz


Seven reports to bring you up to date on the turmoil over UCRP.

1.  How to Measure Investment Performance

     The practice established by The Regents is that their Treasurer provides a quarterly report on the performance of their investments for the retirement fund (UCRP) and also for the endowment fund. The data given there is highly aggregated: one finds investment returns for each major asset class (Domestic and Foreign Equities, Fixed Income, etc.) for various time periods (last quarter, last year, etc.) along with the assigned benchmarks.

     A couple of years ago I presented the Regents’ Committee on Investments with some specific suggestions on how this practice of disclosure could be enlarged and improved: performance data should be provided for each individual external investment manager; peer group comparisons of performance should also be provided.  I noted that other pensions funds, CalPERS for example, routinely provide that level of detail in their published reports.

     When those suggestions got no response, I decided to see what I could do on my own to collect and publish such data. Assuming that the professional staff in the Office of the Treasurer (UCOT) did collect and study that sort of data, I made a formal request for such documents under the California Public Records Act.  The results of that inquiry and subsequent analysis were then published on my web site on August 23, 2006.  See  http://socrates.berkeley.edu/~schwrtz/PerfData.html .
The most surprising information uncovered was that a majority of the external investment managers hired by UC (22 out of 40 firms) failed to meet their assigned benchmarks for performance over the previous year. Six months later I was able to update that study and found that the situation had grown worse.

     In addition, I collected and published data on how UCRP’s overall investment performance compared with that of peer institutions. Some of that looked at how UCRP compared to CalPERS and CalSTRS over several years (very well in earlier years but very poorly in recent years).  Another batch of data looked at a large comparison group of large investment funds. See
Once again, one saw middling to poor relative performance by UCRP in recent years but top rank standing in earlier years (before the Regents brought in Wilshire Associates and kicked out the former Treasurer Patricia Small).

     The letter of transmittal from UC headquarters that provided me with this last collection of data said,

the Treasurer’s Office has moved away from peer group comparisons and has discontinued its subscription to the [TUCS] …  and has no plans to subscribe to any service providing peer group comparison information in the future.

     This background will be resonating in the several recent stories reported below.

2.  A Searing Review in a Local Paper

     The East Bay Express is a weekly “alternative” newspaper widely distributed in this area (which, incidentally, includes the UC headquarters.) Their May 9, 2007, cover story (“Parsky’s Party,” by Chris Thompson) is a substantial report on several contentious issues surrounding the UC Regents’ management of our pension fund.  Rather than trying to summarize it here I will simply encourage readers to find the article themselves at http://www.eastbayexpress.com

     Their May 30 issue has some letters in response to that article, including a strong set of rebuttals from Michael Reese, UC’s Associate Vice President for Strategic Communications. He closes with the startling claim that if the regents had not adopted the new investment strategy (designed by Wilshire Associates in 2000), “the UC retirement plan’s assets today would be approximately $2.7 billion lower … ”  The writer of the article then rebuts that claim, calling it “shameful”; and the June 20 issue carries a letter from former UC Treasurer Patricia Small, who also challenges that claim of Reese’s, calling it “disingenuous.”  Lively reading all.

3.  New Conflict of Interest Charges

     On May 4, 2007, the San Francisco Chronicle carried a story (“Union Calls for Closer Look at Finance Experts”, by Tanya Schevitz) on some new charges of conflict of interest involving members of the Regents’ Investment Advisory Committee. That is a body created in 2000 to integrate some outside investment professionals into the regents’ policymaking. It turns out that members of that body – who meet regularly with the regents’ own Committee on Investments in both open and closed sessions – do not file financial disclosure statements, as do all regents and many other UC officials.

     Some of this topic was presented in my last paper (#24) in this series. However, recent study by Faith Raider, a research analyst for one of UC’s employee unions (AFSCME 3299), shows a much wider circle of problematic situations. As reported in the Chronicle:

[John] Hotchkis has served on the advisory committee about seven years. …[He] retains a 1.1 percent interest in his former firm Hotchkis & Wiley Capital Management, which was chosen in July 2004 to manage more than $430 million in UC equity funds.

Hotchkis was also sitting on the university’s advisory committee in 2005 when a firm headed by his daughter, Sarah Ketterer, was chosen to manage $311 million in non-equity funds. Ketterer is chief operating officer of Causeway Capital Management.

[David] Fisher, chairman of the board of Capital Guardian Trust Co., joined the advisory committee just months before his company was chosen to manage $377 million in fund assets.

     The Chronicle reported that regents were concerned and would consider this issue at their next meeting. The agenda for the May 17 meeting of the Regents’ Committee on Finance announced an item (F9) scheduled for action on this topic. Remarkably, the proposed new policy was even worse than the old one, requiring even less public disclosure. At the regents’ meeting, however, it was announced that this matter was being put over for later consideration. Stay tuned.

4.  An Insider Squawks

     At the May 16 meeting of The Regents, I was surprised when one of the speakers in the Public Comment Period identified himself as Robert Blagden:  he had just recently resigned as Managing Director for Public Equity Investments in the Office of the Treasurer of The Regents and he had some complaints to present; but the short time limit on public speakers did not allow much detail.

     One week later an article appeared in the online publication FundFire (providing “Institutional and High Net Worth Competitive Intelligence”) where we learned that three top investment professionals had recently left UCOT.   From “U of California Loses Top Investment Staff,” by Whitney Kvasager:

Robert Blagden, former managing director of external investment management, managed 65% of the $72.7 billion system’s total assets for four years until he felt compelled to leave in March. He says he and two investment officers left because micromanagement by the recently-appointed treasurer and the 18-member Board of Regents is so oppressive they couldn’t effectively do their jobs. …

This article had more detail from Blagden and also a review of UCRP’s performance and conflict of interest issues. A follow-up story in the June 5 issue of FundFire presented UCOP’s response.

The University of California system is defending itself against criticism of its performance and complaints about its management. UC Associate Vice President Michael Reese says that the university is performing well against internally-set benchmarks and will no longer participate in peer evaluations.

Reese says the number of those who have quit the investment staff does not “rise to the level of newsworthiness,” and that reports of investment advisory committee members having ties to firms that won contracts are not conflicts of interest or ethical lapses.

“It’s a really healthy fund,” Reese says. “Our employees have not had to pay into it for a good many years.”

But when Bloomberg ranked performance of the country’s 25 largest endowments last December, UC was second to worst, with 11.6% returns. …

     What I found particularly significant in that UC response was the absence of any rebuttal or denial of Blagden’s charge about micromanagement by regents into the investment activities of the Treasurer’s Office.  This has serious implications for the issue of conflicts of interest, as I should explain.

     The Regents’ official Conflict of Interest Policy regarding investment activities states that they, regents, are only involved in setting broad policies, the detailed implementation of which is left to the professional staff in the Treasurer’s Office.

… this Policy explicitly separates the roles and responsibilities of various UC fiduciaries to ensure the continuance of sound investment practice and the protection against real or perceived conflict of interest …

The “micromanagement” which Blagden complained about, and which Reese did not deny, appears as a direct violation of this policy and amplifies previous concerns about conflicts of interest in the management of UC’s multi-billion-dollar investment funds. We need to learn more about this situation.

5.  Joint Governance Proposal

     Just recently, the idea has been brought forward that employees of UC should be actively involved in the trusteeship and investment management of the UCRP: Joint Governance is the operative phrase.  Such arrangements are quite common in both the private and the public sectors throughout the nation. For example, the CalPERS Board is composed of 13 members, six of whom are elected by and from the membership of that retirement plan.

     UC is quite unique in that its employee pension plan is entirely internal, controlled by The Regents.  Most public universities use their state’s public employee pension system; and for private universities there is TIAA/CREF.  According to some experts, pension plans with joint governance actually perform better (in terms of their average investment returns) than those where the employer alone manages the fund.

     At the May meeting of the regents there were a number of public speakers from UC employees’ unions who advocated this idea of joint governance; and State Senator Leland Yee has introduced a bill in the Legislature (SCR 52) which calls upon The Regents to institute such joint governance for UCRP under its existing authority to delegate such responsibilities.

     At its first formal hearing, before the Senate Committee on Education, this bill brought out some lively discussion. The exact language of the bill (which is a Concurrent Resolution and not binding legislation) calls for fifty-fifty representation between employer and employees in the management of UCRP. Some Senators pointed out that they could only support the general idea of joint governance and that the specific details of the power-sharing arrangements would have to be negotiated between The Regents and the various other stakeholders. Senator Yee agreed to some modification of his bill’s language to accommodate that view; and then the Committee unanimously approved his bill.

     This bill is supported by many staff labor unions at UC and also by the Faculty Association; the UC administration has not yet taken an official position, pro or con.  It will be most interesting to watch how this proceeds.

6.  Resumption of Contributions into the Pension Fund

     The Regents had planned to restart contributions into the UCRP fund as of July 1, 2007, thus ending the “contributions holiday” they had initiated in 1990. The details were to be worked out in negotiations with employee unions and the plan also depended upon a commitment from the state to provide an additional $60 million in the coming year’s budget.  A crucial detail is how the payments would be divided between employer and employees. UC’s first plan was that these should be equal amounts: a target of 8% of covered payroll to be paid by each party.   With the Governor’s budget failing to provide the $60 million for this coming year, the scheduled resumption of contributions has been postponed.

     As to the division of payments, it is instructive to look back at how this was done in the past. Over the last ten years before the contributions holiday (i.e., the 1980’s) the record shows that the average contribution from the employer (UC) was five times the average contribution from the employees. (The employer contributions came from three main sources: State budget appropriations, Federal contracts and grants, DOE Laboratory budgets.)  One argument is that the previous 5:1 ratio is a precedent that should be followed now; contrarily, one can argue that financial circumstances have changed a lot and the old pattern is irrelevant.  Another argument is based on a concept of equity rather than precedence. During the contributions holiday, employees benefited by not having to pay into the pension fund, but the employer benefited much more - five times as much. Therefore, the employer should now pay in much more than the employees.

     In recent public statements UC has said that it plans to seek state funding in the following year’s budget, with payments into the pension fund to be 11% from the employer and 5% from employees. Obviously, this is a fluid situation under continuing negotiations.

7.  A Mystery Brochure

     Early on June 19, while surfing the UCOP website, I happened to come upon, and promptly downloaded, an interesting file about the UCRP (“retire_plan_bro.pdf”,  2.2 megabyte file, created 6/6/07).  This appears to be a glitzy brochure designed to counteract the idea of joint governance for the UC pension fund.  Some excerpts:

UC’S INVESTMENTS ARE WELL GOVERNED. The UC investment fund’s safety, security and solid performance, combined with its high ethical standards, all point to a system that is remarkably well governed.

UCRP is in good financial health. Its performance for the fiscal year to date (May 25, 2007) is 18.7%. Recent quarter end performance is better than the returns of UC’s peers among 150 pension, foundation, and endowment plans with over $1 billion in holdings.

As of the last actuarial report, the UC retirement plan’s funded ratio was 104%, compared to other California funds that today are only 85-86% funded and to others in the nation that are even lower.

Indeed, if UC had continued to pursue its former [pre 2000] investment strategy, assets today would be approximately $2.7 billion lower. The reforms enacted by the Regents are clearly benefiting all UC employees and retirees.

I am tempted to point out the many contradictions and half-truths in this brochure; but, instead, I will leave that exercise to my readers.

     Strangely, when I went back to find this file later that same day – wanting to send the URL to other interested people – it seemed to have disappeared.  Later on, I typed the name of this file into Google and she was able to retrieve a copy of it at  http://atyourservice.ucop.edu/employees/policies_employee_labor_relations/news_events/retire_plan_bro.pdf   But I still cannot find a link to it on the ucop web site.