In Response to AFSCME Local 3299 and the University of California
By Kyle Vogel, Head Trader and Senior Investment Analyst at Commerce Asset Management, Sub-Advisor of the AdvisorShares QAM Equity Hedge ETF (NYSE Arca: QEH)
A small but humorous riff hidden within the many episodes of Seinfeld involves the titular character’s father learning that he was owed $50 over 53 years ago. The penny-pinching retiree then wonders what he could have done with that $50 payday: “Do you know what the interest on that fifty dollars comes to over fifty- three years? Six hundred and sixty-three dollars and forty-five cents. And that’s figuring conservatively at five percent interest, over fifty-three years, compounded quarterly. Or, if you put it into a ten-year T-bill…” He goes further, “Do you realize, an above-average performing growth mutual fund for fifty-three years…”1
The comedic subtext is that he suddenly becomes a financial wizard by turning a small sum into a large reward, and the larger the reward grows, the angrier he becomes. It is easy to say that my present life situation should be better “if…”, but we cannot possibly say this without regard for the past or the future. A similar yet more serious situation is brewing at the University of California’s pension and endowment office (UC). UC’s largest employee union, AFSCME Local 3299, released a large study ominously titled: “Missing the Mark: How Hedge Fund Investments at the University of California Shortchange Students, Staff and California Taxpayers.” Without going into the details, the union wants to follow CALPERS’s lead and remove the Absolute Return category which would eliminate all allocations to hedge funds and move those assets into fully exposed, lower-fee, passive indexes (mainly the S&P 500).2
Their argument focuses on three commonly used issues and a fourth that surprised me. These probably sound familiar to anyone following the active vs. passive debate: (1) High fees (2) Low performance (3) Lacking transparency and the surprising issue (4) Little protection against market losses.3
Do hedge funds protect during downturns? It has been awhile since we have had an opportunity to answer that question but I wanted to remind the employee union of how different opinions were after 2008 (within the September 10, 2009 minutes of The Regents of the University of California: Committee on Investments):
The University’s portfolio might have performed better if more had been invested in hedge funds. Committee Chair Wachter noted that the University has sometimes been criticized for being too conservative in its investments…In response to a question asked by Mr. Martin, Ms. Berggren stated that the Treasurer’s Office does not anticipate any major new trends in the fixed income or equity markets. Since the end of the year, the portfolio has been positioned to be fairly neutral on equities and fixed income. Absolute return exposures are being increased because there is more flexibility in the hedge fund absolute return area. She stated that the University should seek returns over the next year in asset classes rather than in asset allocation movement…Committee Chair Wachter suggested that a portfolio with good hedge fund exposure would perform better before, during, and after the financial crisis. The University’s hedge fund exposure has been low in the UCRP, where such exposure is needed. While the University has been slow to invest in hedge funds, the selection has been good. He stated that the University needs to increase this exposure in the future.4
Also within “Missing the Mark” is this chart, which was presented to demonstrate the correlation between hedge funds and stocks, however it actually disproves one of their arguments by showing that hedge funds outperformed during the only two periods that stocks were down which is completely ignored within the text.
In April 2014, UC hired Jagdeep Bachhar as CIO. Jagdeep thus far has reduced the number of external managers in his first year from about 70 hedge funds down to around 405 and has been quoted as saying that he will reduce further to about 10 before June 2016.6 He has increased the cash position to use opportunistically.5 Jagdeep intends to negotiate lower fees and invest in his better performing hedge fund managers. Though, in order to negotiate a lower fee, you also have to bring something to the negotiating table which usually results in a bigger allocation to that manager. “You give more money to the people who are doing well for you as opposed to spreading it out.”6 This method of allocating to past winners has its problems (see our post on chasing good returns7), but the reduction in size has many benefits. He will have more active control and enhanced monitoring capabilities over the absolute return category, and he will also have a better chance to overcome lower returns. 70 hedge funds would only increase the chances of central tendency toward the peer average.
UC, under Jagdeep’s watch has also started its own internal VC fund which will invest in ideas generated within the university, a smart way to give back as well as potentially participate in any gains.8 We applaud the innovative management techniques of Jagdeep, and we would suggest to AFSCME Local 3299 to leave him with all the necessary tools to provide UC the best chance of meeting its objectives.
1 The Kiss Hello”, Seinfeld Scripts. <http://www.seinfeldscripts.com/TheKissHello.html>
2 AFSCME Local 3299, “Missing the Mark: How Hedge Fund Investments at the University of California Shortchange Students, Staff and California Taxpayers,” January 2016, p.11-17. <http://www.afscme3299.org/documents/media/WhitePaper_MissingTheMark.pdf>
3 Ibid 2 p.3.
4 The Regents of the University of California, Committee on Investments, Investment Advisory Group, “Minutes,” September 10, 2009. <http://regents.universityofcalifornia.edu/minutes/2009/invest9.pdf>
5 Lilledeshan Bose, “CIO Jagdeep Bachher Works to Invest Wisely at UC,” UCRTODAY, February 10, 2015. <https://ucrtoday.ucr.edu/27181>
6 “University of California endowment to terminate worst-performing hedge funds,” Pensions & Investments, March 10, 2016. < http://www.pionline.com/article/20160310/ONLINE/160319981/university-of-california- endowment-to-terminate-worst-performing-hedge-funds>
7 <http://alphabaskets.com/the-paradox-of-chasing-returns-2/> & < http://alphabaskets.com/the-paradox-of-chasing-returns-part-2/>
8 UC Office of the President, “University of California Proposes Creation of New Venture Fund to Invest in UC Innovation”, September 15, 2014. <http://universityofcalifornia.edu/press-room/university-california-proposes- creation-new-venture-fund-invest-uc-innovation>