by Charles Schwartz, Professor Emeritus, University of California, Berkeley
email@example.com May 4, 2001
>> This series is available on the Internet at
More Dirt to Dig
While still waiting for the promised responses from the
UC President's Office, I present and examine a surprising Inside Story,
which came (second hand) from a key member of the Board of Regents.
The Real Inside Story?
On August 7, 2000, Regent Judith L. Hopkinson, Chair of the regents' Committee on Investments, issued a public letter detailing what changes in investment policies the Board of Regents had adopted on March 16, 2000, following the recommendations of Wilshire Associates. Sometime in September she met privately with a select group of University employees and explained to them why The Regents had made those changes. I first heard about that meeting a few days later, from a representative of CUE, the clerical workers' union, one of whose colleagues had attended. A little later, I heard from Professor Warren M. Gold of UCSF, head of that campus' chapter of the University of California Faculty Association, that he also had been present at that meeting with Regent Hopkinson; and on October 2 Professor Gold circulated his summary of notes from that meeting to a number of colleagues.
The following is the text of the email letter Professor Gold sent to me on October 2, responding to my first issue (Part 1) of this series, "What's Happening with the Pension Fund?" I found this material astonishing and I have long wanted to share it, and to critique it, with my readers.
I have a big problem with the process by which the Regents adopted the change in investment policy. As to the new policy, I understand that our faculty representatives on the Retirement Advisory Board did not have major criticisms of the new plan. They also were most concerned about the process.
As to the policy itself:
I don't have any argument with your commentary about statistics, but I do not think that the stats were the real issue.
The Regents have fiduciary responsibility for the pension program.
First, the Regents felt that the treasurer did a terrific job during a period when everyone who was investing was able to make lots of money.
But the Regents had serious concerns about the investments of the pension funds:
About 2/3 of the funds were invested in stocks, of those most were in a small number of specific stocks at any one time; 1/3 were invested in only 10 stocks! (This portfolio is hardly one that could be characterized as diversified and designed to protect us.) Furthermore, the investment was done by "stock picking" by one or two individuals. It was done well, as proved by the increase in the value of the pension fund. But this is a high-risk investment strategy -- as the economy cools off and with such a large amount of money. Not an appropriate investment policy for a retirement fund! Stock picking is very tough to do by small number of people for such a huge fund.
BONDS--The treasurer had invested in 12-year term bonds. Highly unusual because long term price varies markedly with interest rates. Average pension fund invests in 5-year duration at most. These investments also needed analysis. Because this aspect of the treasurer's policy was also very high risk.
No independent evaluation of the treasurer had been done in a very long time. Most public pension funds have oversight by outside independent analysis agency. UC has not had one done.
Finally, UC never had an overall investment plan for the retirement program. Such a plan was long overdue.
Regents chose a highly competent firm (Wilshire) with a national reputation in this field after considering 4 proposals.
The philosophy of the plan is to decrease risk and volatility while enhancing returns. Risk was of great concern. Thus, the plan includes adding small companies, increased numbers of different stocks, other kinds of investments including foreign stocks, and some nonpublic companies, new targets for bond terms. Diversification is also to be achieved by investment of some of the money in index funds.
I am no expert in investing. I think the stock market is a crapshoot. But the critique of the investment program seems reasonable. The concerns about risk seem very reasonable. The argument about the % return and the problem of statistical prediction that you make sounds reasonable but not the major point of concern.
I hope this information helps.
The first thing I note is that this account contains a number of quite alarming allegations, which have never been made before publicly by any UC official nor can they be found in any of the official documents which UCOP has provided on this subject. If one accepts this story as given, one might well believe that the former UC Treasurer had created a very risky situation for the pension fund, which Wilshire and The Regents had, thank God, rescued.
The next question that comes up is: How authoritative is this account? Perhaps Professor Gold was not accurate in some of his interpretations and notetaking from Regent Hopkinson's talk to that group. When I raised this question of authenticity with Professor Gold, he replied that he also was concerned about this and he wrote (October 7):
CharlieAnd later (October 22):
I plan to distribute my comments to the members of my faculty at UCSF. To ensure that they are accurate, I have asked for review by a faculty member of the Retirement Advisory Board and Regent Hopkinson. When I get their responses back I will be happy to have you include the statement in a future paper.
My reason for doing this is to try to allay anxiety of my colleagues about the pension fund, if that is possible.
The matter of the flawed process is still being pursued by systemwide Faculty Association.
CharlieStill later (November 6), he responded to my query, "Any response from Regent Hopkinson yet?":
The summary I gave was from my notes at the meeting with the new chair of the Investments Committee Regent Hopkinson. I was not the only one present. I have sent the summary to her and asked for her approval, comments, etc. I have heard nothing. I will send her another note this week. I really would like to get her approval of my summary before having you debunk her.
No and I have written her a second time.And more recent communications with Professor Gold show no news from that front.
One can only wonder why Regent Hopkinson did not reply to Professor Gold's repeated inquiries. Given this history, I would say that one cannot fault Professor Gold for any possible inaccuracies in his summary. Further, I would apply the dictum, Silence Implies Consent, to infer that Professor Gold's summary is an accurate account of what Regent Hopkinson presented - if not exactly the Official Word, at least the most authoritative version of The Real Inside Story.
In any case, Professor Gold's summary of what Regent Hopkinson said
has been widely circulated to faculty colleagues throughout the University
and has undoubtedly had a significant impact upon people's opinions
this whole controversy. It is thus important to examine that Story with
a critical eye.
Debunking Regent Hopkinson's Story
I now want to test the truthfulness of Regent Hopkinson's Story by comparing with facts and data which may be collected from official UC records. The issues covered fall into several categories, primary among them is the topic of diversification as the way to reduce investment risk. And I want to compare the UCRP investment picture before and after the Wilshire recommendations were adopted.
Diversification 1. About 2/3 of the pension funds were
Over the previous three years, UCRP investments in Common Stocks were in the range 60%-67% of the total portfolio, while the total portion in equities was 63%-70%.
According to the new UC policy, the common stock portion will have a target value of 60%, with a range of 55%-65%; and the new total equity target is 65%, with a range of 60%-70%. Hardly any change.
Diversification 2. Most of the stocks were in a small number
of companies; 1/3 of it was in only 10 stocks!
Here is some historical data for the UCRP equity portfolio:
As of 6/30/99 it had 77 common stocks; the top 10 accounted for 33% of the value.
As of 12/31/99 it had 80 common stocks; the top 10 accounted for 37% of the value.
As of 6/30/00 it had 85 common stocks; the top 10 accounted for 36% of the value.
As of 12/31/00 it had 80 common stocks; the top 10 accounted for 33% of the value.
-- No Change.
New UC policies (Wilshire's guidelines for U.S. Equity investments) are the following:
1) "The portfolio must contain at least 60 different common stocks." - UCRP was already above this minimum. No change.
2) "The portfolio market value weighting of any individual stock can not exceed three percentage points more than its weighting in the Russell 3000 Index." - According to a 3/31/00 tabulation, there were 6 stocks in the UCRP portfolio exceeding this limit, and only slightly. Reducing all of them to be within the Wilshire-specified limit amounted to a combined reduction of only 2.4% of the equities value. Very slight change.
3) "The portfolio market value weighting of any individual industry [electrical, retail, pharmaceutical, etc.] can not exceed ten percentage points more than its weighting in the Russell 3000 Index." - According to the 3/31/00 tabulation, UCRP was already in compliance with this guideline for diversification. No change.
Diversification 3. Add foreign stocks.
As discussed in Part 4 of this series, the preexisting portion of non-U.S. stocks in UCRP was already at the level recommended by Wilshire. No change.
Diversification 4. Add stocks of smaller companies.
As discussed in Part 4 of this series, this move achieved Very little or no change.
Diversification 5. Invest some of the money in index
This would make sense if the previous claims were true. However, as we now see, and as we discussed this in Part 4 (and in Part 7) of this series, this move to index funds may do more harm than good.
I previously said, in Part 4, that the changes in the Bond portfolio (shortening the average duration of the bonds from 11 years to 7 years) was non-controversial because the former UC Treasurer, Patricia Small, had agreed to this Wilshire proposal early on. For a more critical examination of this matter, see the Appendix of this paper.
Management Risk. the investment was done by "stock picking"
by one or two individuals. This is a false statement.
The recent Annual Reports of the UC Treasurer's Office lists a staff of 14-16 Investment Management professionals, along with a larger number of supporting personnel. A February 11, 1999, document from the Treasurer's Office provides a more detailed breakdown of the investment management professionals:
7 Equity investment officers
4 Fixed Income investment officers
1 investment manager for each of: private equity, real estate, and trading
2 top level managers supervising all of this
Selection of a consultant. Regents chose a highly competent firm (Wilshire) with a national reputation in this field after considering 4 proposals. The Facts are Different:
Regent Parsky sent letters to four firms on February 2, 1999, inviting them to submit proposals by February 12, with the work to be completed by March 31, 1999.
William M. Mercer (New York) declined because, "Our firm provides other services to the University in a number of areas and we believe our existing relationships with the University would create an appearance of, or an actual, conflict of interest."
Frank Russell Company (Tacoma) replied, "We believe it would be difficult for us to do a quality job in this time frame. ... Should you consider changing the due date for the completion of this project, we would be enthusiastic about submitting a proposal."
Wilshire Associates (Santa Monica) and Callan Associates (San Francisco) both submitted proposals but also expressed serious concern about the shortness of the timetable for completion of the work. As it turned out, Wilshire got the job; and the date for completion of the work was moved. Their first presentation to The Regents was not until January 2000.
I conclude that Regent Hopkinson's story was a bundle of disinformation, intended to create a very false image of the previous UC investment picture and thus to dispell any criticisms over what Wilshire Associates and The Regents had done. I do not know whether Regent Hopkinson was aware of these fabrications, or was merely the dupe of some other miscreant.
Was any of this misinformation fed to gullible regents during the hours
of secret meetings when Wilshire's advice was delivered to them? Here is
another powerful reason for insisting that the minutes of those meetings
be made public.
Appendix - UCRP Bond Investments
Let's look at what the Wilshire report had to say about policies for the bond investments in UCRP (page 15 of their March 16, 2000, Investment Strategy Study):
"Wilshire recommends that The Regents adopt the Salomon Long Pension Fund (LPF) Bond Index as the overall performance objective for its 35% allocation to fixed income. The Salomon LPF Bond Index is used by large pension funds, like CalPERS, that seek a longer duration for their bond portfolio to more closely match the longer duration of their benefit liabilities. ...The numbers they give contradict the logic they espouse. Given the two alternative durations, 10.4 years and 7.4 years, which one more closely matches 16 years?
"The Treasurer's Office manages a very long maturity bond portfolio whose return is compared with ... the Lehman Long Treasury Index (a long 10.4 year duration). The recommended Salomon LPF Index has a 7.4 year duration, ...
"Wilshire has calculated the duration of the Plan's liabilities to be approximately 16 years, ..."
Wilshire concludes, putting aside that discussion of matching durations,
"Our view is that the 7.4 year duration provides a better return and risk profile for the UC Pension Plan..."
and this is a claim we can examine using the data on Fixed Income Returns and Risks recently provided by the UC Treasurer's Office. In Part 7 we looked at this kind of data analysis for the Stock portfolio; here we turn to the Bonds.
Over the past 20 years, UCRP investments in bonds have consistently
shown higher returns - and also higher risks (standard deviations of annual
returns) - than either of the benchmarks: Lehman Brothers LT Index or
Brothers LPF Index. In order to compare these "return and risk profiles",
we need to calculate some risk-adjusted numbers. My results (using the
same method as in Part 7) are shown in Table 1, below. The new policy
a significant sacrifice of returns, in the long run, even after allowing
for the much lower risk level of Wilshire's new benchmark.
|Over the last ...||5 years||10 years||15 years||20 years|
|Annualized Returns for
|Risk-Adjusted Returns for
UCRP Bonds vs.
|Lehman LT G/C/Y Index||6.8%||9.2%||10.3%||10.9%|
|Risk-Adjusted Returns for
UCRP Bonds vs.
|Salomon LPF Index||6.5%||8.6%||9.7%||10.4%|
Again I would ask, Has Wilshire provided
UC with any such quantitative analysis?