Not So Silent Partner

Corporations watch out! The biggest pension fund of all is on the track of better performance. Like other activist institutional investors, in the 1990s it’s going after the kind of corporate governance it wants.

December 1 1990 by Richard Rescigno

What does a pension fund behemoth need to lumber into the future? Clif Wharton is the answer. The behemoth’s name is TIAA-CREF, standing for Teachers Insurance and Annuity Association-College Retirement Equities Fund, which named Wharton chairman and CEO in 1987, making him head of the nation’s single biggest pension fund, with assets exceeding $83 billion.

The twin organization’s assets are split almost 5 to 4, with a few billion more tipping the balance in 77AA’s favor. TIAA was formed first, in 1918, as a higher education pension fund, and CREF and variable annuities came along in 1952. Today both funds operate on a mammoth scale. A 3 percent change in the stock market in either direction equates to about a $1 billion move in the market value of the CREF stock portfolio. While in 1989, TIAA made a total of $7.6 billion in new investments, the equivalent of about $30 million for each working day.

When you’re that big it’s not easy to exceed average returns. But TIAA-CREF ran up an admirable record, staying ahead of the averages for many years. Its strategy was to go only for long-run value, usually acquired at a highly favorable price, and stick with it through ups and downs. But the key to its success may prove to be its undoing. What allowed TIAACREF to hold on throughout the cycle was the fact that it’s annuitants couldn’t take their funds elsewhere. They were locked in, and as yields fell off in the 1970s they grew increasingly disgruntled.

The policyholder revolt sought higher yields, a money market account, and transferability. It had two strong supporters in the form of college and university employers pressured by costs and the threat of unionized professors, and later the SEC, which requires that money funds satisfy its own contributor requirements. Transferability became a reality in 1990. TIAA-CREF knew that transferability meant escalated competition from firms like $117 billion Fidelity Investments. Enter Clif Wharton, on his third career, and willing to streamline the giant.

Can TIAA-CREF be a viable competitor? The vote is still out. For the period ending June 30, the CREF stock account achieved a one-year return of 15.11 percent versus 16.40 for the S&P 500 Index. Taking a five-year range, CREF was up 17.65 percent versus 1 7.21 percent for the index. Chief Executive asked James S. Martin, executive vice president for CREF investments about those returns. He explained that CREF is more than 70 percent passive, with its funds tied to the S&P 500 index. When you’re over $40 billion, day trading is an impossibility. The active 30 percent of the CREF portfolio is two thirds into domestic issues, and one third invested internationally. And Martin thinks that global is a key way to greater returns.

Felix Zulauf, president and CEO of Swiss-based Zulauf Asset Management, told Chief Executive that giant-size investors like TIAA-CREF will turn more and more to international investing in order to keep returns high. The competition knows that too. “Investment success in the 1990s,” Edward C. Johnson 3rd, Fidelity chairman and CEO, said recently, “will depend on how well investors exploit the entire world.” And CREF’s Martin indicated that recently the fund has invested as far afield as Chile.

On the TIAA side of the house, executive vice president for investments J. Daniel Lee, Jr. is innovating as well. TIAA’s portfolio is essentially fixed income in character, with real estate (including New York‘s Seagram building), mortgages and direct private placement loans hedging the bond exposure. Lee told Chief Executive that only 10 percent of the public bond portfolio is in the high yield category, with actual junk bond exposure at about $600 million. That’s several billion dollars less than a number of the nation’s largest private insurers.

But the pressure for greater and more competitive returns is strong. Pension assets tripled in the eighties to some $2.5 trillion, and sheer size is aggravating the return problem. (See related comments by Richard Rescigno of Barron’s, p. 62, and Blackstone Group’s Peter G. Peterson, p. 18.) That economic reality coupled with increased competition has increased the activism of giants including TIAA-CREF. As L. Gordon Crovitz wrote recently in Barron ‘s, “When it comes to issues of corporate control these days, truth is in the eyes-and muscled forearms-of the institutional investors.”

Crovitz had the example of the California Public Employees’ Retirement System (Calpers) in mind. Under the leadership of CEO Dale M. Hanson, Calpers led a headline-making activist attack against Pennsylvania anti-takeover legislation. With $58 billion in pension funds and investments in some 1,300 public companies, Calpers is clearly a force to be reckoned with. The same firms that fled raiders in the 1980s by running into the arms of the institutions may not find their embrace as satisfying in the 1990s.

The issues institutional investors want their way on can be social as well as economic. TIAA-CREF, under pressure from professors and guided by Wharton, opened a Social Choice Account (SCA) in 1990. That’s symptomatic of thinking that goes well beyond the 1988 Labor Department ruling that all pension fiduciaries must vote their proxies. But there’s an irony in activism as well. Social choice can cost. For the SCA’s first four months ending June 30, the account (which invests in both stocks and fixed-income securities) returned only 5.75 percent. That’s higher than the aggregate bond index return of 3.73 percent, but a lot less than the 9.05 percent return racked up by the S&P 500 Index.

Wharton has been asked to remain at the TIAA-CREF helm, despite pending retirement. A University of Chicago Ph.D., he spent 13 years working on agrarian reform in southeast Asia. In 1970 he became president of Michigan State. Eight years later he was named chancellor of New York state’s higher education system. His TIAA-CREF appointment followed. At a salary of more than $560,000, Wharton is one of the highest paid black executives in the country. He accounts for his success simply, telling Chief Executive ‘s editors that work in the Third World taught him “the significance of human capital.”


Many CEOs are beginning to worry about the bigger-than-life role that institutions are adopting. Will TIAA-CREF assume an activist stance?

Soon after I came somebody said, “Oh boy! Wharton has displayed prior sensitivity on social issues. TIAA-CREF is going to become very activist.” But we are quite different from almost any other institutional investor. We are not only non-profit, but we are an institution whose customers are our shareholders. And we have a very special relationship with the academic community. That is reflected in the characteristics of our hoards, whose members view their responsibility, in relationship to TIAA-CREF as an institutional investor, as normally activist in nature. For that very diverse group it’s a major responsibility.

Together we’ve created a joint committee of the board on corporate governance and social responsibility. That committee is entirely made up of outside trustees or directors. It has the responsibility of developing TIAA-CREF policies that relate to all matters dealing with corporate governance and social responsibility on the equity (CREF) side of the house. They have also, from time to time, dealt with issues that are similar on the TIAA side, but there we can exercise our prerogatives as bondholders, or direct lenders.

This committee reviews major issues that are going to be coming up in the next proxy season, when votes will have to be taken. During the proxy season they will review, on a case-by-case basis, special instances where there are questions about whether or not a particular proxy proposal fits into the policy that they previously developed. The committee, in certain cases, will express an interest in meeting with management of the firm before the proxies are submitted. In a case involving Dayton Hudson, the proxy that we submitted related to a proposed poison pill. This led to discussion in which management agreed to certain things, and we concurred and withdrew.

This is not a case where we have a political agenda. We do not. It depends on our sense of whether or not a specific issue has a positive or a negative effect on the expected long-run return on an investment. The question of institutional activism per se is not the way we approach this issue. Many times we see actions being taken by other institutional investors who, from our perspective, are not coming at issues in the same way. They will say, “Well, are you interested in supporting this, this and this?” We say, “We don’t operate that way.”

What if you have a situation where your investments may be put in jeopardy?

It depends upon the particular instance. The committee may request that I send a letter to the CEO involved. We did that with Emerson Electric, and with Loews. Given the dramatic increase in the proportion of stock held by institutional investors, corporate America will have to come to grips with the implications of the changed relationship between shareholders and managers. We have simply not successfully come to grips with the implications of what is involved there.

I am not certain that we have in place sufficient means to deal with poor performance. Institutions like TIAA-CREF are so large that much of their assets must be indexed and treated passively from an investment standpoint. We do not have the same kind of flexibility as an individual stockholder who can move in and out at will. We have not yet found adequate means whereby we can begin to deal with the new financial environment. All of us have got to find better ways in which we can deal with the changed nature of the relationship, and the fact that we do have corporations now in which the majority of stock is held by large institutional investors. That’s a reality, and it’s going to grow.


What issues are CEOs, or senior management, most likely to get thumped on in the proxies sent in by TIAA-CREF?

Last year institutional investors were involved in the issues of representation on boards and the selection of CEOs.

And their pay?

And their pay. But “practicality” also gets into the picture, along with the issue of appropriateness. We hold stock in some 1,500 corporations. It would take an enormous amount of time to learn about proposed directors for 1,500 corporations.

You’ve said that your organization is in for the long term. CEOs, for years, have bewailed what they regard as the short-term orientation of our financial institutions. Doesn’t one of you have to be wrong?

Some CEOs are extremely good at developing a long-run strategy, and allocating resources between the short, intermediate and long run. They’re also good at explaining that, both internally and to analysts, giving everybody a good idea of what they’re trying to accomplish. When CEO’s are able to do that, they are more than halfway home as far as winning a higher level of tolerance and understanding. If there is, in the short run, less-than-adequate performance, it’s accepted because investors know and understand what the long-run strategy is. They can see what the CEO is doing about it, and how he or she is moving in that direction. If a CEO does not have a well-defined long-run strategy and is not adequately allocating, and does not explain it adequately, that’s when you begin to get in trouble.


Where does Clif Wharton stand on the corporate responsibility spectrum?

Each and every social action has equal weight with regard to its impact, positively and negatively, on earnings. Milton Friedman was one of my professors. [Laughter.]

But you’ve created a social choice investment account for your annuitants. What’s excluded?

It’s non-nuclear, non-weapons, non-tobacco and non-alcohol; it excludes South Africa and certain companies in Northern Ireland. We don’t have a hit list. We don’t have a list of firms we’re not going to invest in. We were very careful in our choice of a name for the fund. We did not call it a socially responsible account because that implies that others are irresponsible. This is a social choice account, and the choice belongs to the individual.

When it comes to investing in South Africa, do you or don’t you?

In the case of CREF, we invest in firms that operate in South Africa, but we have a policy of, in certain cases, submitting proxies that say to the firms, “We want you to get out of South Africa, or we want you to stop having an indirect relationship with South Africa.” In the SCA, we have ruled out investments in South Africa.

Does the SCA currently screen for environmentally acceptable companies, beyond its prohibition against firms which produce nuclear energy?

We’re working on it. A trustee committee has been wrestling with the idea of how to implement a new screen. I’m thinking seriously of having a special session to go at this in depth. We feel very strongly about trying to get environmental concern written in-this is an issue with a much broader base, and it’s going to be very much in evidence.


You’ve indicated that about 70 percent of CREF assets are indexed. Isn’t it going to be very difficult to beat the current market?

We have gone through market drops before. But if you have a long-run strategy and you have both the passive component and the active component and the international component, not only are those segments frequently countervailing and offsetting, but also, in the long run, you get the kind of return that we’ve been getting. But that’s because we have had that long-term orientation. Sure, you make some mistakes, but then we’ve beat the 12 largest insurance companies for 40 years. If you start worrying about the little flips and flops, that sort of moves you off your long-run game plan. That doesn’t mean you don’t make minor adjustments as you go along, but you stay with it if you believe in it.

How active is your global component?

Among institutional investors we are international pioneers. We were the first to move abroad vigorously, and we’re still the largest. A significant international dimension is necessary for CREF. But on the TIAA side of the house, we’re constrained from significant global involvement. That involves regulatory issues. The reality of broader, global markets means it’s going to be very difficult to perform well unless there are some major changes in both state and federal statutes for insurers.

For CREF, you’ve set a target of 15 percent for international equity investments. Do you think that could climb to 20 percent in the future?

When you start looking at the relative importance of global markets, you realize suddenly that ours is not the only market in the world. We recognized that early on, but I wouldn’t even begin to guess how far we’re likely to go.