Where we can, we focus on investments over 10 years and beyond. This offers many more opportunities than those available to short- and intermediate-term investors. We aim to make the most of our scale and ability to be patient.
Jagdeep Singh Bachher
and Vice President of Investments
We have a renewed focus on alignment of interests; that is to align ourselves with our stakeholders and service providers to deliver the needed results in tough global financial markets.
The job of the Office of the Chief Investment Officer of the Regents (UC Investments) never changes: We work tirelessly to protect and grow the money we manage for the University of California.
We keep a laser-like focus on our key objectives:
- To honor our UC Pension obligations to approximately 270,000 members*;
- To help our approximately 300,000 participants in the UC Retirement Savings Program improve their retirement readiness;
- To make payouts to about 5,400 UC Endowments; and
- To meet the annual operating budget needs across the UC system.
It’s a big responsibility, and we are honored to fulfill it.
If we look back over the last five, 10 or even 20 years, UC Investments has done a commendable job. For example, over 20 years, we show a positive annualized net return of 7.7% in the UC Endowment and 7.2% in the UC Pension. Since its inception in 2008, the UC Working Capital (Total Return) shows annualized net returns of 7.0%. Overall, we’ve grown our total assets under management from $32.9 billion in 1996 to more than $100 billion today. The University of California has a strong financial foundation, and we are proud to have played a role in helping create it.
However, while the past has been generous to our Office and University in investment results, the present and future are presenting increasingly parsimonious pictures. The 2015-16 fiscal year brought a perfect storm of events that affected all institutional investors. This included slow growth in China, persistently low interest rates, declining oil prices, and the Brexit. As a long-term investor, we know storms come from time to time, and we are prepared to weather these markets. However, we are now in a longer-term trend of low returns driven by lower global growth. As such, even with our long time horizon, it may be difficult to achieve our stated objectives of expected investment returns in the UC Endowment and UC Pension.
The writing was on the wall back in 2014, and we took it very seriously. Rather than just accept the fate of a low-return environment and reduce our ambitions as an Office and as a University, we have spent two years proactively repositioning UC Investments for a low-return environment. We’ve been re-designing our investment organization—and even our approach to accessing investment opportunities—and we’ve started the process of restructuring our organization.
First, we realized that as a management team, we needed to come to some agreement as to our identity—both current and potential future—as an investor. During my first year as CIO, we had hours of discussions about how to articulate exactly what it is we believe about the world, what we believe about financial markets and what we see as our place therein. We ultimately turned this exercise into a formal set of “investment beliefs,” which you’ll find later in this report. These beliefs guide us in everything we do.
Next, with a renewed sense of our identity and a set of investment beliefs that we could hold, we began to consider the core operational pillars, the practical and operational versions of our more theoretical investment beliefs, that we felt might lead to a successful organization. Again, we went through a consultative process that involved our management team, but we also began to investigate the best practices of our peers and service providers and how these best practices could fit into our unique circumstance. And once again, we wrote these pillars down in a formal way so they could guide everybody in our organization (read our 10 Pillars document).
Finally, after aligning our stakeholders with our key objectives and setting out the principles of our organization coherently, we then turned to the hard work of remaking ourselves in the image of the organization we had painstakingly drawn. This has been hard work, much of it difficult to quantify as it is often about building culture. Still, to help crystallize some of what we’ve been doing, I’d like to share with you a few examples of what we’ve achieved over the past two and a half years (30 months) in terms of internal changes:
- Products: We are now managing each of our products with bespoke strategies, which means the UC Endowment will no longer be an afterthought to decisions made for the larger UC Pension fund (or vice versa). For the first time, every client and product will get the appropriate consideration from UC Investments.
- Collaboration: UC Investments is part of the broader UC, but the University had been an untapped resource for our organization (and vice versa). We’ve spent a lot of time rebuilding our links with the University, which has required resetting our culture toward more open and transparent communication. Today, we feel as though we are truly a part of the UC ecosystem and are seeing the benefits in our investments.
- Risk Management: We have built a best-practice risk system, and we’re leading the development of a new agent-based system that will further bolster our understanding of our exposures in times of crisis. We believe that all of our team members are risk managers, and this is now manifesting in our systems and policies.
- People: We are nothing without talented people. As such, we have designed a new compensation policy that will allow us to recruit top talent, while appropriately aligning them to the long-term success of our organization. We sought to strike a balance between the market demands for a performance based compensation system and the perception of what’s fair in a public context. We believe we’ve achieved a good balance and the quality of our candidates for key roles continues to inspire us.
- Data: We recognize that we need to know where we are today to be able to decide where we go tomorrow. That’s why we’ve developed a new data policy and are rolling out a new architecture. We also recognize that the next 30 years of investing will demand that we get our data in a format that we can use. There is no machine learning or artificial intelligence without clean data, and we are doing the hard work today to position ourselves for the future.
- Simplicity: We’ve simplified our portfolios and exposures by cutting the number of active managers and their associated costs. Our baseline today is to start with an assumption of passive management to get a risk exposure we desire and then only employ active managers if they can demonstrate some ability to use a market inefficiency to generate performance.
- Transparency: We’ve gone from a culture of secrecy to championing transparency, both internally and externally. We believe the best ideas and arrangements should be able to thrive under the bright lights. We recognize that some of what we do needs to remain confidential to prevent tipping off the broader market to our intentions or eroding a timely competitive advantage, but we always try to balance these tactical needs with our strategic belief around openness.
- Alignment: There is a great deal of capital in the world chasing a small number of attractive opportunities. We see this as one of the great threats to our long-term performance, as the mismatch in supply and demand of capital often leads to a similar mismatch in alignment between service providers, such as asset managers and us. In our new vision for our organization, alignment is the most important factor in our success as an investor. In the pursuit of this, we have pulled out all the stops:
- Fees and Costs: We have engaged our teams to help us get fee and cost transparency throughout our portfolio. This has helped us understand what the true incentives are in our contracts and better understand the ways in which asset managers have historically aligned with us as asset owners. The fee savings have been considerable, and our understanding of alignment of interests has improved by leaps and bounds.
- Innovation: We’ve seeded two new funds with like-minded family offices to target unique strategies and opportunities around the globe. One fund targets energy innovation here in the United States, while the other targets technological innovation in India.
In all cases, we are developing these networks and capabilities because we want to develop unique access to the best performing funds. We want to cultivate a reputation for adding value to our partners and have them seek to involve us in their endeavors. We have size, scale, patience, and the UC ecosystem. We really are unique, and, as such, we are cultivating all of these assets to advance our position as a global investor.
These are but a few examples of the hard work we’ve been doing to position this organization for success. We are confident that, while the past 30 months have been challenging, 30 months from now we’ll be in a very strong position. It takes time to put these large organizations on a new path, but we’re very happy with our positioning today.
In closing, I want to reiterate this idea because it’s important: our job at UC Investments is to take the long-term view, learning from what’s happened in the past, setting realistic expectations, reporting with transparency and clarity, and responding with agility and intelligence. This is how we navigate the investing landscape of the future and serve the university in the best way possible, for the long term.
Office of the Chief Investment Officer of the Regents
*As of June 30, 2016, includes active, inactive, terminated, and retiree membership.
University of California
As President of the University of California, I work with UC Investments to ensure that the University manages its current and future financial obligations prudently on behalf of our students, employees, and the State of California. While the 2015-16 fiscal year presented some challenges, it was also a year in which we made important strides toward existing and new goals.
We continued our work on various projects in areas of critical importance to the University, to California, and to the world. One such project is the UC Ventures Program, which enables the University to actively support innovation and entrepreneurship across the UC community through early-stage venture capital investment. The University’s Innovation and Entrepreneurship Initiative has been instrumental in moving UC’s cutting-edge discoveries into the world economy.
In last year’s annual report, we outlined the University’s first-ever sustainable investing framework. We have made significant progress in implementing this framework over the last year. At UC, we believe that environmental sustainability, social responsibility, and prudent governance factors inform our understanding of the current and future business environment, provide an important metric for evaluating risk and improving long-term returns, and help us become better stewards of our assets and the planet.
Like many other institutions, the University has also had to navigate the low-return environment that persists in the global economy. So far, we have managed this challenge with thoughtful investment decisions. In the coming year, we will also reassess our performance goals in light of this ongoing global trend. This collaborative re-evaluation process will involve a variety of stakeholders at UC. Our goal is to create a performance benchmark roadmap that will guide us through a challenging and uncertain period, and help us ensure continued growth and a bright future for UC.
University of California
Chair of the Committee on Investments
This was your inaugural year as Chair of the Committee on Investments. What were some of the highlights?
Probably the most important thing this year was continuing to right-size the UC Investments organization. I was as surprised as Jagdeep Singh Bachher at the number of managers we had. Active managers have, by and large, failed to meet or beat benchmarks, so couple that with what they’re being paid in a low-return environment and it’s clear it doesn’t make sense. I anticipate there will be an ongoing evolution to passively manage a sizable portion of the portfolio.
How will this shift benefit UC?
For too long, managers have been paid a lot of money in fees while not delivering performance. In the public sector, we’re accountable to our stakeholders and it’s very important that we’re transparent about our approach: we’re trying to get the healthiest returns at the best costs, and not pay people unless it’s earned. I don’t have a problem paying people performance fees as long as we’re getting performance, i.e. returns in excess of benchmarks.
So now we’re focusing with precision on those key external relationships to get the maximum benefit and working to shift our strategy to passively manage a more significant part of our portfolio.
How does the “flat is the new normal,” low-return environment affect UC?
The main effect is one of forcing us to get more realistic about our performance expectations. Here’s why: Most predictions of GDP growth are modest. Focusing on equities and fixed income and blending them, we cannot safely say that we’re going to have high single-digit returns going forward. So as it relates to our pension and endowment, we have to plan accordingly and reduce our expected rate of return.
It can be a painful conversation to have, but it could be even more painful in the future if we don’t recognize this issue now and adjust expectations. More than likely, we will need to reduce the rate of return in small steps, reevaluating along the way as needed.
Of course, we’re not the only ones grappling with this. It’s the new reality. And I’m sure Jagdeep could confirm that this is a conversation that’s happening at organizations and educational institutions around the country.
What was the response of the Regents when you presented this idea of reducing the expected rate of return?
There was a consensus that we have to be realistic about this right now. It affects the UC Pension most acutely because the Pension is a finite pot of money that has to be there to satisfy our liabilities. There’s no power to tax like the U.S. or state government has, so we have to deal with it.
The UC Ventures Program is thriving. How do you see this program evolving in the near future?
I am truly excited about the UC Ventures Program. We have such an incredibly successful and innovative environment here, and because we have a significant sum of money to invest, it makes perfect sense that we support the work that’s coming out of our own organization—of course, making sure our investments are appropriately sized given the risks involved.
I also love that with these innovations, particularly those in the medical field, we have the opportunity to generate returns for our stakeholders while also having a major positive impact on society.
What are your views on the importance of how environmental, social and governance (ESG) factors influence our overall investment strategy?
No one can invest today without taking ESG factors into account, and because we are stewards of the university’s money, we always have to ask the question: How do ESG factors affect each class? Further, since UC leads the world in mitigating the impacts of ESG factors such as climate change, it makes perfect sense that we should take those impacts into account when we evaluate our investments.
So what’s next for the Committee on Investments?
It is important for us to set realistic expectations. Pundits predicted that it would take a long time to come out of the last recession, the worst since the Great Depression. They were right. What will change that paradigm or when, I don’t know. All we can do is be prepared by resetting our expectations and reevaluating them every few years.
Finally, I look forward to continuing the open-door, open-phone, open-email policy Jagdeep and I have with each other. It’s a true partnership.