Category Archives: Education (higher ed)

Digging into Rate-of-Return Assumptions


by James A. Bacon

House Speaker William J. Howell is rightfully concerned about the long-term health of the Virginia Retirement System. The pension system’s own actuary estimated a year ago that the $68 billion retirement system has unfunded liabilities of $22.6 billion.

On Sunday, the Richmond Times-Dispatch’s Michael Martz described the debate over restructuring the VRS from a defined-benefits system to a defined-contribution system. Today, Martz reports how Howell is questioning the outsized fees paid to outside fund managers, who handle two-thirds of the system’s assets.

“My biggest concern is the unfunded liability and the fact that it’s just going to grow,” Howell said.

Howell has every reason to be concerned. Unfunded liabilities might turn out to be far bigger than the actuary’s estimate. As I have observed many times, the liability is based upon an assumed 7% annual rate of return on the $68 billion portfolio. If the system under-performs expectations, as the VRS has done the past two years, the unfunded liability can grow by tens of billions of dollars. Writes Martz:

For Howell and other lawmakers on the [Virginia Commission on Retirement Security & Pension Reform], however, the retirement system’s recent investment performance has raised questions about whether the 7% assumed rate of return is too optimistic for the longer term, especially with interest rates keeping bond yields low for the foreseeable future. …

The 7 percent return, lowered by the VRS board from 7.5 percent in 2010 is among the lowest in the country for public pension funds, said Katie Selenski, state policy director for the Pew retirement initiative. “At 7 percent, you’re in a good, prudent position.”

Prudent? Not really. The pie chart above shows VRS’s portfolio allocation. Some 17.6% consists of fixed income assets. Barring some bizarre experiment with negative interest rates in the U.S., there is no way in a zero interest-rate environment that these assets can generate a 7% return. Another 39.8% of the portfolio consists of equities. Insofar as the bull market in stocks over the past 30 years has been driven by lower interest rates and an expansion of earnings multiples, there is no way to replicate the stock gains of the past ten years. Indeed, earnings and earnings quality of stocks are deteriorating, not a good sign for near-term price performance. Meanwhile, the performance of hedge funds nationally has been dismal of late. There is no rabbit to pull out of the magic hat of alternative investments.

For another view on the outlook for long-term portfolio performance, it is instructive to turn to the University of Virginia, which, whatever one might say about the Board of Visitors’ strategic priorities, one must credit with doing an excellent job of managing its endowment. The 10-year return of the University of Virginia Investment Management Company (UVIMCO) has been 10.1 %, according to its 2014-2015 annual report. That compares to 5.8% ten-year performance calculated by the VRS in 2014-2105.

How much do UVa’s masters of the universe think they can earn on their portfolio looking forward? As best as I can tell from perusing UVIMCO’s annual report, they don’t say. UVIMCO doesn’t report that assumption because it isn’t relevant:  Although UVIMCO does have unfunded commitments, it is not a pension fund in which shortfalls must be made up by taxpayers.

Still, it is possible to get a sense of UVa’s expectations from comments made by university officials that they expect the controversial $2.2 billion Strategic Investment Fund to throw off $100 million a year to pay for programs to advance the university’s strategic goals. University officials have not explained what rate-of-return assumptions they are using. But a simple calculation reveals that $100 million is only 4.5% of $2.2 billion.

From that, one can draw one of two conclusions. Either UVa’s investment mavens are assuming a much lower rate of return than the VRS, or they expect a higher-than-4.5% rate of return but plan to retain a substantial fraction of the earnings, presumably in order to grow the size of the portfolio.

It appears that the second conclusion is true. Here’s what the UVIMCO annual report says: “Each year a portion of the endowment value is paid out to support the fund’s purpose, and any earnings in excess of this distribution help build the fund’s market value over time. In this way, an endowment fund grows and provides support for its designated purpose in perpetuity.”

For legislators digging into UVa’s controversial Strategic Investment Fund, which is managed by UVIMCO, it would be interesting to know what rate-of-return the university is assuming for its endowment and what percentage it figures on spending and what percentage it figures on retaining. The numbers should be equally interesting to Speaker Howell. It would send out a flashing yellow caution signal if the UVIMCO’s assumption about of future performance was more conservative than that of the VRS.

A Bright Line between Research and Academic Funding at UVa?

Gerald Warburg, professor of public policy at U.Va.’s Frank Batten School of Leadership and Public Policy.

Gerald Warburg, professor of public policy at U.Va.’s Frank Batten School of Leadership and Public Policy.

by James A. Bacon

Gerald Warburg, a professor of public policy at the University of Virginia, provides important context for the university’s controversial, $2.2 billion Strategic Investment Fund. In an op-ed published a week ago in the Virginian-Pilot, he describes the fund as a tool to boost the university’s research mission without relying upon state funds or tuition dollars. The fund should serve as a national model for public universities, he says. He writes:

A decade ago, cuts from Richmond made clear legislators’ conclusion we could no longer afford to bear the financial cost of maintaining world class, state-subsidized research universities.

During the subsequent recession and recovery, U.Va. administrators struggled to reinvent a model public research university. …

Today in Virginia, the funding responsibilities are clear. Tuition, endowment and modest state support will fund access to education and training. The university and external sponsors of academic research are responsible for funding research. No other university in America has addressed this challenge as successfully as the University of Virginia.

Read the whole thing. It’s the most coherent justification I’ve yet seen for the Strategic Investment Fund.

Bacon’s bottom line: If I understand him correctly, Warburg is saying that UVa is drawing a bright line between its academic mission and its research mission, and that the academic mission is funded by tuition and state support, while the research mission is (or will be) funded by the Strategic Investment Fund and external sponsors. Politically, this is an astute way to frame the issue because it alleviates fears that students and parents are helping pay for UVa’s research ambitions.

Creating that bright line is a worthwhile goal, if it can be achieved. I laud Warburg for articulating it. Research universities really do cobble together two distinct missions — academics and research — each of which really should have their own dedicated sources of funding. Students should not be asked to subsidize corporate and federally funded research.

But I have two questions: (1) Are the academic and research functions so intertwined and the funding so inter-mingled that it is even possible to separate research from academics, and (2) where did the money come from to seed the Strategic Investment Fund in the first place?

UVa has not even tried to answer the first question (in fairness, no one has yet asked it), and it has yet to give a clear and comprehensive explanation of the second. University officials have said that some of the funding came from university reserves and some from squirreling away savings from “efficiencies.” One might speculate that other funds have come from budgeted monies unspent at the end of the fiscal year, or budgeted monies not spent on construction projects, or monies accumulated from hospital operations in the same way that the Inova and Carilion health systems have used surplus revenues (what normal people would call profits) to fund their own research initiatives. One could make the argument that any of these sources, known and speculated, were extracted from students or patients and, from an ethical perspective, should be used to reduce tuition and hospital charges.

Hopefully, we’ll be learning the details Aug. 26 when the House Appropriations Subcommittee on Higher Education and the Senate Finance Subcommittee on Education hold hearings on the Strategic Investment Fund.

Infographic of the Day: Cost of Nonresident Students

The 2004 Appropriation Act allows the boards of visitors of public Virginia universities to set tuition and fee charges for out-of-state students at levels based on competitive market rates, provided that “the tuition and mandatory educational and general fee rates … cover at least 100 percent of the average cost of their education.”

Based on published fees and projected enrollment, SCHEV has calculated that every institution will charge tuition & fees above the average cost of education this year.

Bacon’s bottom line: In theory, out-of-state students are money makers for Virginia universities, which charge them significantly higher nominal tuition and fees than what in-state students pay. I say “nominal” because out-of-state students don’t necessarily pay the full freight any more than in-state students do. Indeed, it is readily apparent from comparing this chart to the nominal out-of-state tuition and fees that universities provide significant discounts and/or financial aid to attract the out-of-state students they want.

Thus, to cite an institution that has been in the news lately, the University of Virginia charges undergraduate students admitted to the College of Arts & Sciences this year nominal tuition and fees of $45,066 dollars if they are out-of-state. But, according to the SCHEV chart, average tuition amounts to only $35,385. (Complicating the comparison is the fact that the latter number reflects average cost of both graduates and undergraduates, and also includes upper class students whose fees have been frozen while incoming students were jacked up 10%. Still, those factors don’t account for a nearly $10,000 discount.)

To take a simpler example, George Mason University charges nominal out-of-state tuition and fees of $32,392. But according to the SCHEV numbers, the actual tuition is $29,426 — a different of almost $3,000.

Nevertheless, it is clear that out-of-state students subsidize in-state students. To pick UVa again, the average per-student cost is $24,429 but the actual in-state tuition charged is only $14,476. It’s tempting to complain about UVa admitting too many out-of-state students, but the sky-high tuitions they pay help hold down the cost for Virginia students. On the other hand, given the large number of out-of-staters that apply to Virginia, one can legitimately ask whether it is necessary to provide such a large discount.

Strategic Investment Funds: Not Just for UVa Anymore

uva_fog_smallby James A. Bacon

The University of Virginia’s controversial $2.2 billion Strategic Investment Fund is such a great idea that UVa officials are recommending it as a model for other state universities.

By adopting UVa’s approach and consolidating university reserve funds statewide, a sum that could approach $9 billion, the Commonwealth could establish an investment fund that would generate $450 million annually in extra income, UVa Rector William H. Goodwin said Monday at a Board of Visitors meeting, reports the Richmond Times-Dispatch.

Vice Rector Frank Conner also recommended the investment strategy for other Virginia public universities. “A lot of people will be calling us,” he said. “This is very creative.”

Members of the UVa board are upset by questions swirling around the creation and purpose of the fund, the existence of which was revealed publicly in a Washington Post op-ed last month by former Rector Helen Dragas before the university could manage the roll-out. Questions have arisen regarding where the money came from and why it won’t be used to dampen tuition increases rather than fund programs to enhance the university’s prestige.

Board members pushed back yesterday against outside criticism. It is “a shame we’re getting arrows in the back for being first,” said James B. Murray Jr.

Barbara J. Fried said the university needed to do more to “overcome lying sound bites.”

But the university has been slow in explaining exactly how UVa’s Strategic Investment Fund was accumulated. A month ago, the official explanation was that the money was cobbled together from $385 million in operating reserves, $620 million in “unrestricted funds and related earnings that had accumulated in [the university’s] history,” and $700 million in earnings on those funds. The university provided no detail on the $620 million in “unrestricted funds and related earnings,” and legislators have called for an accounting.

Goodwin added a bit of new detail Monday. He credited Executive Vice President Patrick D. Hogan with, as the T-D put it, “finding efficiencies in operations during the past few years that, along with investment earnings, were used to create the fund.”

Bacon’s bottom line: Let’s make one thing clear: It is great news to discover that UVa has compiled a $2.2- to $2.3-billion pot of money. That money can do a lot of good.

Apparently, UVa, like other universities, kept a lot of cash sitting around in reserves yielding very low interest rates, and Hogan deserves credit for figuring out how to tap those funds to generate a higher return in other kinds of investments. Among other things, this involved negotiating a line of credit to maintain the university’s liquidity. The payoff from this financial restructuring could be huge. If Goodwin is right and the idea could be applied to other Virginia universities, the innovation could very well revolutionize higher education finance. (The idea must be viewed with caution, however. Not all institutions have a AAA credit rating like UVa; some may not be able to leverage their balance sheets in the same way.)

But no one is criticizing the board for being creative financial stewards and investing the money well.

People have legitimate questions about where the money came from. According to UVa’s own explanation, only $385 million of the seed funding came from operating reserves. Another $620 million came from what is described as “unrestricted funds and related earnings that had accumulated in its history.”

What the hell does that mean?

Well, we learn from Goodwin that a good portion if not all of that $620 million come from operating efficiencies — cost cutting. Again, Hogan deserves kudos for the achievement. But no one is criticizing him for running a tight ship.

These are the questions that people are asking: Should UVa have used the savings from cutting costs to blunt increases in tuition and fees rather than setting them aside and accumulating $620 million? Who set up this operational fund anyway? Did the Board of Visitors ever approve the strategy of setting aside and accumulating funds from cost-cutting initiatives, a strategic decision that should be made by the board and not the administration? Did the board approve handing those monies to the University of Virginia Investment Management Co. (UVIMCO) to invest? When the board recently voted to increase tuition for incoming students by 10%, were members aware that the university had accumulated hundreds of millions of dollars, plus investment returns, from cost cutting? Did board members give consideration to the possibility that the accumulation of those funds represented a form of overcharging students and their families?

Legislators want answers, and I don’t blame them.

Goodwin Says Closed Meeting Was Legal

William H. Goodwin, rector of the University of Virginia, has disputed the account by former rector Helen Dragas that a June Board of Visitors meeting held in closed session violated the Freedom of Information Act.

The Freedom of Information Advisory Council issued an advisory opinion Friday saying that the board appeared to violate the law, assuming events unfolded as alleged in a letter written by Virginia Beach attorney Kevin E. Martingayle at Dragas’s behest. (See details of the opinion here.)

During a break in the orientation program for new board members Sunday, Goodwin told the Daily Progress that the narrative was inaccurate, but declined to get into specifics. “I think it was disappointing they would write such a lengthy article based on what one person said,” he said, referring to the 5,000-word opinion.

The board voted to hold a closed session to discuss personnel and legal matters. Dragas, whose term on the board has since expired, said that the board discussed substantive details of a $2.3 billion Strategic Investment Fund, a topic that should have been aired in open session — a charge seemingly backed by the distribution of guidelines for spending revenue from the fund that were tagged for discussion in “executive session.” University officials retorted that board members “asked questions about the Fund that deviated from the designated personnel topic” and that when university counsel brought it to his attention, Goodwin “ended the discussion.”


FOIA Case Against UVa Tightens

uva_fog_smallDiscussion of a controversial $2.3 billion Strategic Investment Fund in closed session during a University Virginia Board of Visitor’s meeting appears to be a violation of the Freedom of Information Act (FOIA) — assuming events unfolded as alleged in a letter by an attorney representing former Rector Helen Dragas, concluded Maria J.K. Everett, executive director of the Virginia Freedom of Information Advisory Council in a staff advisory opinion released today.

Virginia Beach attorney Kevin E. Martingayle asked for the opinion in a letter describing Dragas’s version of events at the board meeting, her last before being rotated off the board. In that meeting, she dissented from a vote to certify that the closed session had been held in compliance with the FOIA.

Wrote Everett:

The answer to your question is therefore “yes,” it would be a violation to hold a closed meeting to discuss a fund when the motion to convene the closed meeting was for purposes of discussion of personnel, legal matters and litigation.

The open-meeting exemptions allowed for “personnel” and “legal matters” do not cover “general policy or other matters that may eventually have legal consequences,” Everett wrote.

However, the law does not set forth any remedial action to be taken by the public body, in this case the UVa Board of Visitors. The statutory remedy for a FOIA violation, Everett wrote, is “a petition for mandamus or injunction supported by an affidavit showing good cause.”

While University of Virginia officials have stoutly defended both the justification for the $2.3 billion fund and the manner in which it was approved by the board, they have met Dragas’s FOIA charge with silence.


UVa InfoWars

uva_fogby James A. Bacon

For policy junkies following the tit-for-tat between members of the General Assembly and the University of Virginia over the controversial $2.3 billion Strategic Investment Fund, I am providing some of the documentation underlying the ongoing reporting on the subject (such as this article in the Richmond Times-Dispatch today.)

First, a letter from Patrick D. Hogan, chief operating officer of the University, responding to a request for information from 13 members of the General Assembly.

Second, the legislators’ response to Hogan’s response.

The conflict at the moment centers on which documents the university should make available. Hogan argues that the original request was unclear and burdensome, and, further, that the university was not in possession of records belonging to the University of Virginia Investment Management Co. (UVIMCO), which manages the Strategic Investment Fund. Nevertheless, he said, the university was making every effort to comply with the information request.

The legislators were not satisfied with the response. They retorted that the solicitation of documents was not a Freedom of Information Act request, which allows various exemptions, but a legislative request. The Code of Virginia, the letter reminds Hogan, provides that “the rector and Visitors of the University of Virginia shall be at all times subject to the control of the General Assembly.”

As for the failure to turn over UVIMCO documents, the legislators said:

We find it difficult to understand why UVIMCO has been placed off-limits regarding requests for information and documents. We observe that organization is called the University of Virginia Investment Management Company with over $7 billion in assets, and exists solely for the benefit of the University. We also note that Mr. Hogan sits on its board and oversees a chief executive officer who appears to have earned over $2 million managing university funds in 2014. In light of these facts, we restate and insist on full compliance with our original legislative request….

In other developments… Former rector Keith Martin had an op-ed published in the Washington Post defending the university administration and current Rector William H. Goodwin Jr. Much of the op-ed repeated familiar talking points, but Martin did provide new details (new to me anyway) on the origin of the Strategic Investment Fund.

To support a AAA bond rating in the face of fluctuations in the value of the endowment and political uncertainties such as the inability of the state to formulate a budget on time, UVa had to maintain 330 days of liquidity. That required UVa to set aside a large sum of money as a reserve. In large part, Martin explained, the investment income from that reserve is what will fund the strategic, university-enhancing investments.