The University of California Retirement Plan continues to try to maintain solvency as it struggles to pay down billions of dollars in unfunded liabilities as a result of its poor investment returns over the past five years.
A defined benefits program, the UCRP guarantees its employees a certain percentage of their income upon retirement, and therefore bears much more burden for ensuring good returns than an institution with individual retirement plans.
Institutions like the UC fund their plans by deducting a portion of every employee’s paycheck – an amount typically matched by the employer – and contribute them all into a general fund, which is subsequently used for investments.
Returns on the investments are used to fund current retiree payments as well as grow the fund for future retirees.
The UC’s pension fund consists of holdings in a mix of stocks, bonds, real estate and other investments held with groups ranging from foreign governments including Venezuela and Hungary, to companies like McDonald’s Corp. and fellow public institutions such as the University of Texas.
Despite the wide scope of the UCRP’sinvestments, many of them are in line with typical pension fund compositions for similar institutions.
For instance, both CalPERS and the State of Wisconsin Investment Board maintain a similar scope of holdings, according to each of their investment reports.
The UCRP’s total worth at the end of the 2012-2013 fiscal year amounted to more than $45 billion, an amount that places it among the top 100 pension funds globally. About $1.1 billion of that total is invested in emerging market debt, according to the most recent annual report.
Investments, ranging from the UCRP to the endowment, are managed by the Office of the Chief Investment Officer of the Regents for the UC, though final investment policy is determined by the Board of Regents in consultation with the chief investment officer.
The chief investment officer makes guidelines regarding investment decisions for all of the UC funds from the general endowment to the UCRP. The UC’s new CIO Jagdeep Singh Bachher assumed office two weeks ago, said Dianne Klein, a UC spokeswoman.
Before becoming the UC’s new CIO, Baccher was an executive vice president of Canada-based Alberta Investment Management Corp., where he was employed since 2009.
Investing in management
While the Office of the Chief Investment Officer directly manages a sizable portion of the UCRP’s funds, management is mostly passed to non-UC managers.
The UCRP uses around 240 external managers such as hedge funds or investment banks to manage its equity investments including stocks and real estate, which make up 75 percent of the UCRP’s funds, Klein said.
Generally these managers invest UCRP funds on behalf of the UC for an agreed-upon fee.
In 2002, the UCRP relied on external managers for only 24 percent of its funds, according to an article from Charles Schwartz, a physics professor at UC Berkeley.
Before that, the UC almost completely managed its own funds, including stocks, and only relied on external managers for some venture capital investments and emerging market holdings, said Patricia Small, a former UC treasurer.
The UC as an institution was very avant-garde then, being an early investor in emerging markets, venture capital and foreign bonds, mostly directly chosen and managed, Small said.
Small said there appears to be movement away from direct management of funds, unlike when she was there.
In comparison, last year CalPERS only used external managers for about 18 percent of its overall portfolio.
While the transition from direct to indirect management occurred for a variety of reasons, it began in the early 2000s after Small’s departure from the UC.
The over-reliance on external managers, especially hedge funds for the general endowment, has been a drag on performance, said James Ryans, a doctoral candidate at the UC Berkeley Haas School of Business.
Small added the problem appeared to be possibly due to poor external managers with possibly high fees. The UC, unlike CalPERS, does not make clear the fees it pays to external managers.
“Transparency is always wise,” Small added.
Public disclosure requirements of California laws governing financial reporting of its state pension funds intimidate some investors, who prefer elements of secrecy, Ryans said.
Overall, hedge funds outperformed the Standard and Poor’s 500 index in seven out of the nine years from 1999 to 2008, and early investors, like those with Yale’s endowment fund, prospered from investments.
But hedge funds have not returned the same way in recent years, and have thus negatively affected the UC, which got into the game late in both the UCRP and the general endowment, where the concentration on hedge funds was even heavier, Ryans said.
Changing composition
Since the onset of the recession, the UCRP’s funded ratio, which represents an institution’s ability to meet its long-term promised benefits, declined from 110 percent in 2006 to 78.7 percent in 2013.
In the 1990s, the pension was so overfunded that the UC stopped contributions to the fund by both itself and its employees, relying only on returns from its investments, said Paul Golaszewski, an analyst at the Legislative Analyst’s Office, which provides nonpartisan analysis and policy advice to the state legislature.
During that time, UC investments consistently ranked in the top quintile on returns, Small said.
However, even then the Treasurer’s office opposed lowering contributions to zero – perhaps to low rates, but not to zero, Small said.
Golaszewski added that the 1990s proved to be an abnormal time in terms of return, and non-contribution eventually began to really hurt the UCRP’s long-term solvency in market downturns like the Great Recession.
A return to contributions being made by both the UC and its employees has ensued.
Its sizable unfunded liability prompted the UC to demand more employee contributions to the pension fund in contract negotiations, rising on July 1, 2014 to 8 percent for employees hired before June 30, 2013 and 7 percent for those hired after July 1, 2013.
In return, the UC is increasing its contribution from 12 percent to 14 percent for both types of employees.
Since the UC can’t legally renegotiate payments promised to current retirees, they can only rely on investment returns or increased contributions from its employees to fill the solvency gap.
The primary focus of investment choices is the return on investment because the fund has a legal responsibility to pay out its agreed terms to retirees. All other considerations are secondary, Klein said.
Despite losses of 5.74 percent in 2008 and 18.81 percent in 2009 during the recession, the UCRP grew strongly, maintaining double-digit growth for two years before slacking during 2011-2012 to only 0.37 percent, according to the UC’s Treasurer’s Annual Report.
The underperformance occurred even when the markets on the whole prospered. Although as a public institution, the UC is generally more conservative about risk than some other funds, Klein said.
Being conservative in this sense typically means there are fewer years of losses and lower yields when times are good, but the UC’s investments suffered more years of losses than other, private institutions with more aggressive strategies. For instance, Yale’s endowment fund lost money in fewer years than the UC, only posting a loss in 2009 while the UCRP posted losses in both 2008 and 2009, according to the Center for Investigative Reporting.
Golaszewski said returns from investments alone won’t suffice to fill the solvency gap, as the gap already includes a presumed return on investment rate of 7 to 7.25 percent.
The UCRP would have to far outperform this rate, which seems unlikely, he added.
Unlike other funds, like CalSTRS, the pension fund for California public school teachers, which have its contributions defined in state statutes, the UC has the ability to set and negotiate on contributions by both the University and its employees, said Nick Shroeder, an analyst for the Legislative Analyst’s office.
In a sign of the success of the reforms so far, increased contributions and investment returns of 11.7 percent have slowed, while not yet reversing, the growth of the UC’s unfunded liability by the end of the 2013 fiscal year, according to the UC’s Retirement System Annual Financial Report.
The UC hopes the UCRP reforms will slowly reduce the liability and provide for its members over time.
The time has come for a soft freeze for UCRP and Calpers. It is not fair to tax payers to carry this burden, and not fair to employees to pay an increasing amount of UCRP without having the choice to not partake.