For a vulture, John Biggs is a pretty nice guy, says John Bogle, chairman and chief executive of Vanguard Fund.
A backhanded compliment?
Well, not quite. “I was speaking at the American Life Insurance Council about the future of financial services,” recounts Bogle. “I told the insurance company presidents, ‘You will have to get costs down because there are a lot of vultures around who will take this business away from you.’ Then I spotted John, so I pointed and said, ‘One of them is right there.’ But I meant it as a high compliment.’ My next sentence was, `And Vanguard is another.’ “
Viewed a scant decade ago as a stodgy dowager whose main virtue was ranking as the world’s largest private pension fund, Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF) has since struggled to overcome a legacy of lethargy. The company originally founded in 1918 by Andrew Carnegie to provide retirement security for educators gradually evolved into a huge pension system with two arms: TIAA, an insurance company for people employed in higher education and research, and CREF, a pension system offering eight variable annuity accounts, including the CREF stock account-the largest single-managed equity fund in the world.
Today, TIAA-CREF continues to be a mega-player in the institutional investor game, its $223 billion arsenal of assets under management outgunning the holdings of the second and third biggest
As the only defined contribution plan on most campuses, TIAA-CREF enjoyed a virtual monopoly for the bulk of its lifespan. Only when some universities began to allow in competitors like Fidelity, Vanguard, and Scudder during the late ’80s did The Teachers offer participants greater flexibility and a wider range of investment options, including a stock index fund, growth stocks, bonds, global equities, and a money-market fund.
TIAA-CREF’s next wake-up call came last year, when the Taxpayer Relief Act removed the company’s 80-year tax exemption, a radical shift in status that affected every investment in the company’s then-$91 billion TIAA portfolio. The move was a mixed blessing for The Teachers, bringing with it the challenge of paying the new tax without decreasing participants’ annuity payments, but also freeing the company to explore new market segments.
“We couldn’t even offer IRAs to our participants when we were tax exempt,” explains Biggs, who began his career in actuarial management at General America Life Insurance Co. in 1958. Having subsequently served as president and CEO of Centerre Trust Co. and vice chancellor for administration and finance at
The Teachers has won high marks for the performance and low-fee structure of the series of new offerings spawned by its change in tax status, which include a retail real estate fund and a family of six mutual funds (see table, above). Like the company’s CREF stock account, which minimizes risk by investing in a broad range of stocks, the open-end mutual funds are long-term oriented, trim costs by limiting trading, and avoid high-risk actions.
“I probably have more respect for TIAA-CREF than for any other firm in this business,” says Bogle, who notes that communicating its new funds to the retail marketplace may be the company’s biggest challenge. “It may take a few years, but there’s no doubt in my mind that they will become a major factor in the mutual fund industry. They have a sensible investment strategy-index-oriented, playing down the middle, and running at a very low cost. They will be tough competition for us.”
Bogle speaks of his fellow vulture with equal enthusiasm. “I like the cut of his jib,” he says. “John Biggs is a solid citizen. He’s a gentleman. He’s got a good mind, and a tremendous sense of personal integrity.”
Unlike CalPERS’ in-your-face approach to dictating appropriate governance principles, The Teachers takes a kinder, gentler stance. “Our idea is that we can probably do more good by going out to see as many of our portfolio companies as we can,” says Biggs.
But the behind-the-scenes effort hasn’t precluded public skirmishes altogether. Three occasions over the past year saw TIAA-CREF flexing its institutional muscles to protect the value of its investments-filing a shareholder resolution urging Walt Disney Co. to restructure its board, rounding up proxies and turning out the entire board of directors at cafeteria company Furr’s/Bishop’s, and negotiating reforms at ERAMET, a recently privatized French company.
“We have a fairly standard set of corporate governance standards,” explains Biggs. “But when those easy ones are violated we have to take a position.” The great bull run of the past 16 years spawned a succession of such shareholder initiatives. But how will heightened institutional investor activism fare amid the continuing turbulence of today’s market? And will The Teachers continue to make the grade?
In a recent meeting at TIAA-CREF’s
How is a conservative pension system like TI -CREF coping with the kind of volatile market that brought Long Term Capital Management to its knees?
CREF financial, which oversees our stock, is comprised of half academic superstars and half money management superstars. We wouldn’t get snookered by a naive, academic argument like those guys did. Long Term Capital had brilliant people who [except for John Medwether] did not have deep roots in actually managing money. It’s very easy to be swept along by what derivatives can do. That’s what happened to Bankers Trust. But we use derivatives in an appropriate and cautious way, mainly taking risk out of the portfolios and as hedges on currency. We’ve been inoculated.
I find myself very uneasy about what’s going on elsewhere.
We have a growth fund that’s had a good record, but a lot of people want emerging markets funds and aggressive growth. If somebody wants that kind of fund, they ought to invest someplace else. We do a better job with a core fixed-income type of investment.
How do you plan to manage risk in an increasingly stormy market?
In terms of our investment strategies, we let the participants decide where they want to have their money. And if they elect to have it in a growth stock fund, we will have that virtually 100 percent invested. So the only place where it would befit us to take a position is to say that this may be a time where participants want to consider changing their allocations.
My advice to anyone now is to have assets in different asset classes to get ready for whatever turbulence we’ve got coming. You should have a big stock position-60 percent or 70 percent because the returns will be good. Retirement’s a long-term investing horizon. I would never recommend going all cash. Even for a person who’s risk averse, we would never go below 25 percent in stocks. Conversely, 75 percent is the top.
I would also say don’t do anything suddenly. I have a good friend who called Fidelity at and put in a sell order for his entire portfolio. That kind of thing is financial suicide. People did it after ’87 and lived to regret it. So we urge people really uncomfortable with where they are now to lighten up and put some money into real estate accounts that have different investment patterns or in inflation index bonds that have liquidity and transferability.
The products we have brought out in recent years have been alternative investment products that let people diversify. We brought out a retail real estate fund in 1994 that now has more than $1 billion in it. We brought out an inflation index bond account that has kind of an interesting different pattern altogether from typical bonds or stocks. We had not brought out a new stock fund for about five years, so that’s an implicit message to diversify.
How has the loss of TIAA-CREF’s tax-exempt status affected your business?
One week after President Clinton signed that law, we announced our IRA products and within one month, we had $100 million. We announced a family of mutual funds in fall of 1997. We also started creating a trust company subsidiary. We have 20,000 participants that have more than $1 million with TIAA-CREF and those people are calling in with estate planning questions. We’ve surveyed them and they all have about an equal amount of assets outside TIAA-CREF mutual funds and other investments. We don’t want the $10 million fortune. It’s not going to be a walk-your dog trust company. We used the thrift loophole, so it’s a savings bank, and it’s national. We’ve based it in
We have finally gotten through the regulatory hurdles in June and it’s open and the business is coming in very nicely.
AN APPLE FOR THE TEACHERS
You’ve recently been designated the trustee of the Family Tuition Accounts by
Absolutely. We couldn’t have done the
At the same time, we’ve negotiated with a consortium of more than 100 private schools on a tuition guarantee plan so that you can pay in money now and guarantee the tuition at the current rates for the future. You don’t get any investment returns. The school gets the investment return, so if the investment is better than the tuition rate increases, the school wins.
Is managing 401K programs for companies in your gameplan?
No, I don’t think so. For-profit companies do that, whereas we might take on the 401K of a not-for-profit firm. It’s a question of how big-and how diversified-you want to be. My feeling is that we will be most successful by concentrating on our market of two million people and keeping our roots in academia and our style and values arriving out of that.
We’re comparable in some ways to the United States Automobile Association (USAA) [insurance provider for military personnel] in terms of the kinds of service we offer and the customer loyalty we have. I think USAA made a mistake by going with products that are not as good as their core products. Our feeling is that if we’re not in the top 5 percentile with a product, we shouldn’t be in that business. We could lose the confidence of our customers. We don’t want to try to be all things to all people. If it’s not something we can consider worthy independent of our other offerings, let the people get it someplace else.
Why would someone choose your six trust funds as opposed to the hundreds of options offered by Fidelity or Vanguard?
We came into the mutual fund business with a Vanguard-type product in terms of expenses. Everybody else is charging 1 percent to 1.5 percent for asset management. Our funds are all at 35 and 45 basis points. We have an international mutual fund that has a 45 basis point charge. You can’t buy that anywhere else. But that’s consistent with being not-for-profit.
Having a concentrated size also distinguishes us from the others because we can keep our expenses very low. We have fewer funds, but they’re huge, so the actual administration and operation is a lot cheaper. If our funds don’t get to be $1 billion in size, we get very concerned. So I’m very conservative when it comes to adding funds. Right now we’re debating whether we want to add a municipal bond fund, and whether we can do it at 25 basis point charges. Nobody else in the market offers that, so we’re trying to see if we can do it.
What’s your investment strategy?
The best way I can describe what we do is by talking about the growth fund that we started last fall with 850 million from TIAA as seed money. We immediately indexed that $50 million to the Russell 2000 and then used an enhanced index approach that should give us an extra quarter percent to half percent return over the pure index. But it’s an actively managed fund so that as the money came into it, the portfolio manager invests when he can beat the Russell 2000 growth index. When he can’t, he just puts it back into the enhanced index. We describe it as an accordion, the index fund. Today, probably 60 percent of that growth fund is in active positions, but the guy running it doesn’t have to immediately go in, as a typical mutual fund manager does, and spread the money out on a bunch of investments. He’s got his core and if he can’t beat the index, he shouldn’t be there. So it’s a different style and it’s worked wonderfully for us.
Shareholder power grew immensely during the great bull run of the past 16 years. Can it survive in a bear market?
Why not? We’re not as aggressive as some in advocating shareholder value; we respect companies’ other obligations. I don’t think any company should ever exploit any one of its constituencies for the benefit of others. I don’t think we ever push to exploit employees or the community, for the benefit of the shareholders, but directors have a fiduciary duty to put the shareholders first.
We’re frequently lenders on the fixed income side, so where I’m particularly sensitive and where we intervene is when the bondholders haven’t had the benefits of the shareholders. A lot of people will say, “If we can take it out of the bondholders and give it to the shareholders, it’s our fiduciary duty to do that,” but that’s just fundamentally wrong. The automatic statement that shareholder value is all we’re here to produce can lead to the most corrupt action by a company; people get carried away by it. Once you’ve given your public shareholders their 15 percent growth and earnings, you can relax. We don’t have to give them 40 percent or 60 percent or 80 percent
Do you see stock options as diluting future earnings?
A sensible program is a good program. I like stock options when they’re at a reasonable level, but 40 percent or 50 percent of the value of the company? The stock options piling up in companies induces the management to take this aggressive stance that all that matters is getting the stock price up. Customer satisfaction, good products, being a good citizen, running a good company that’s successful all get suppressed by this drive towards option compensation and shareholder value.
CREF doesn’t have any stock options. We’re a general trust, not-for-profit organization. But we have a compensation system that’s focused on participant value, so that if we do a good job in service and if we provide good investment performance for our customers, then our employees get rewarded. Having that single focus-our customers-creates a very different kind of company. Customers aren’t a means to enrich yourself; you’re trying to enrich them.
What’s your take on the CEO compensation issue and the pay-for-performance trend?
A lot of places have gone overboard, and that is a concern. We’ve always said, if you’re going to have these big awards, you’d better have a good process that’s open and fair. We filed a vigorous shareholder resolution at Walt Disney Co. on board independence, fought hard, and got quite a vote. My hunch is that the Ovitz deal and the Eisner deal are good deals for the shareholders and probably within the market for those people. But to have Eisner’s personal lawyer chair the compensation committee does not give me confidence. The company had him step down as chairman while he negotiated Eisner’s contract, but then as soon as the negotiations ended, he stepped back on. It seems to me if you’re going to have an award with an actual value of $100 million, you ought to be sure you have an independent group of people making the decision.
Whenever we see a big award, we ask questions about the quality of the board, and if we’re not satisfied, we’ll take action. But we’re not crusaders on compensation. We can’t be. With 2,200 companies, how do you tell if this guy really deserves what he’s getting? We can’t be smart enough to go in and say what’s right and what’s wrong, but we can go in and have a good representative group for shareholders.
Do you take issue with firms that use aggressive accounting to boost earnings?
I get concerned when we find a token rubber-stamp audit committee. CEOs ought to make sure they’ve got good people on their boards to staff the audit committees. We’ve had a couple of battles over independence. Nucor Steel was a wonderful company, with wonderful results and a chairman with a gutsy way of doing business. But in the interest of saving money, he didn’t pay his board. He had a nominal board that met the stock exchange’s definition, but it never met. The audit committee consisted of the former treasurer of Nucor. That’s a fundamental investor protection that we as shareholders ought to have-somebody good and independent in a company, who will make sure financial statements are reliable.
Nucor at least performed. Irregularities surfaced at companies like Sunbeam, Cendant, Livent, and
We do, but the problem is we have about 2,200 American companies in our portfolio. We have a corporate governance audit procedure. We visit as many companies as we can, have a CEO conversation, and nose into things like the audit committee, the nominating committee process, and who’s on the board. We have Ken West, the former CEO of a Midwestern bank, who goes out and talks to firms about their practices. There’s a whole array of corporate governance issues where we can probably do more good than having a media-driven kind of program to kind of scare people.
Dale Hanson really did a lot for corporate governance with CalPERS’10 Worst Boards list. They were very public, and given their resources, that was probably the best way for them to go. But for us, going and seeing individual companies is better. Most of the time we come out and say, more power to you.
How do you determine which of the 2,200 firms to probe?
We have a database that we carefully developed in the last few years with all the characteristics that we get from public material on a company’s corporate governance. For instance, we’ll have every one of the anti-takeover defenses they have. There are about six defenses, and if a company has all six, that gets noted and we may go after them on their poison pill process. Whereas if a company has none of that, but they have a poison pill, we’ll forget them.
You filed a brief addressing shareholder concerns in the AMP/AlliedSignal case.
We’re not taking sides with Allied or AMP on economic issues-we’re big shareholders in both of them-but AMP has a poison pill that’s got to offend anybody.
It’s called the Dead End pill. If the shareholders vote out the board that’s there and elect a new board, the new board does not have the right to redeem the poison pill. The only board that can redeem the poison pill is the one that’s there currently. That’s the Dead End. It’s the ultimate form of outrageous takeover defense. To say that the new board can’t redeem the pill is to make it absolutely impossible for anyone ever to buy the company for the shareholder’s benefit.
You also took issue with the management at Fures/Bishop’s. Why all that trouble over a small chain of cafeterias?
We would have done that with any company that did to us what Furr’s/Bishop’s did to us. What started out as a loan got converted into a stock position and we ended up owning 17 percent of the company. Then management did some extraordinarily outrageous things. The CEO put in a golden parachute and special provisions to protect himself and take a big salary out of the company. It was self-enrichment, basically. Various factions within the board were at war and the stock was going straight south. So we got proxies from the institutional shareholders, which made up about 80 percent of the ownership, and the Ma and Pa folks too. We voted out the whole damn board and put in a new board. The new board fired the management. Now we think it can be salvaged.
What happened in
with the management of ERAMET? France
The French government had privatized ERAMET, but kept a major stake in it. Then the French government had a local problem with a group of people and the way they solved it was to give them a mine that belonged to ERAMET, so we intervened and said, “You can’t do that, the shareholders own that mine and there has to be some kind of recompensation. You’ve got to buy it from us at the original price and then give it to them.” These Europeans had never thought about that, so it was an interesting contest of American versus European values.
So you’re taking your governance principles across the
Most of our overseas efforts have been at the market level and the government-regulation level-an annual visit, say, in
There’s been steady progress. I think the success of American corporate governance has not been ignored by the Europeans, nor the Japanese. They’re beginning to think that there may be something to Anglo-American governance. We’re really making headway toward international standards.
How will the euro affect your non-U.S. portfolio? Have you switched from investing by country to investing to by sector?
We did that about a year ago, and it’s a good approach toward investing. On a technical level, just getting our systems corrected so we can handle the dual expression of every bond. Most of what we have in the TIAA life insurance side is dollar denominated, but at CREF we ordinarily don’t hedge what we have in stock in dollars, so we have a currency risk, and that’s a concern.
Have you ever thought of allying with pension funds in
We did have some allies among the European institutional investors on the ERAMET case. But we try to be as independent as possible, so we wouldn’t have any formal links with any European group. I’m frightened by this public specter of a bunch of us getting together and beginning to march in and say, okay, we’re going to tell you how to run your company. We think it’s risky for the really big players to get together and form common policies.