by Charles Schwartz, Professor Emeritus, University of California, Berkeley
firstname.lastname@example.org October 30, 2000
>> This series is available on the Internet at http://socrates.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
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.
Members of the Regents Committee on Investments - March, 2000
Subsequently, as of July 1, 2000:
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.
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:
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.
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.