With $160 bn in assets under management, holding an estimated 1 per cent of US stocks, TIAA-Cref is among the world’s most formidable investors. In its mission to find long-term shareholder value for its 1.8 mn participants, the fund maintains a philosophy of socially responsible investment. Thousands of companies come under the microscope, scrutinised through strict, bottom-up security analysis and probed on a range of corporate governance and social issues. But once won over, TIAA-Cref is distinguished by its dedication to long-term investment.
TIAA-Cref dates back to 1905 when the non-profit Teachers Insurance and Annuity Association was established to provide retirement benefits and other forms of financial security for employees of educational and research organisations. Organised into a defined contribution plan in 1918, TIAA allowed its often-transient members to move between institutions without losing retirement benefits. Today TIAA’s $79.8 bn in assets is invested in direct loans to business and industry, publicly traded bonds, commercial mortgages and real estate.
The other side of the equation, the College Retirement Equity Fund, was created in 1952 to complement TIAA offerings with a variable annuity fund based on equity investments. By 1988, TIAA-Cref’s combined assets totalled $70 bn from over a million participants, many of whom were eager for more investment options. In response, Cref decided to add a money market fund, bringing it under the oversight of the SEC, and requiring complete transferability, even outside of TIAA-Cref.
Transferability to other pension providers made TIAA-Cref vulnerable to flashy competitors, and it began adding investment options to its members. Cref, officially an open-end diversified management investment company, now has a broad range of products under its umbrella, in addition to the ‘classic’ Stock Account which is the largest single managed equity fund in the world. The Money Market Account was followed by Bond Market and Social Choice Accounts in 1990, the Global Equities Account in 1992, and the Growth and Equity Index Accounts in 1994.
According to Virgil Cumming, senior vice president and director of global active management at TIAA-Cref, the fund’s strength is its long-term outlook. ‘We are not in the quarterly performance derby that many funds are in,’ says Cumming, who joined TIAA-Cref in 1971 as an investment officer. ‘TIAA-Cref is investing pension money, which has a very long-term horizon. We don’t buy and sell based on last quarter’s earnings or next quarter’s estimates.’
Rather, the fund managers typically base their decisions on an 18 month horizon. Cumming says that individual managers can adjust the 18 month time-frame for certain securities, but the guideline stands as a good starting point and it is reinforced by the fact that the incentive plan for portfolio managers is based on three-year performance.
The long-term approach seems to have produced aggressive performance curves over time. The flagship Stock Account has shown a ten year cumulative return of 274.48 per cent, or 14.12 per cent per year – outperforming the 13.24 per cent average annual return posted by the Lipper General Equities Fund Average. The Cref Growth Account returned 35.2 per cent in 1995, compared with a ten-year average return of 13.42 per cent for the Lipper Growth Fund Average. Meanwhile, the Equity Index Account showed an outstanding return last year of 36.17 per cent. The portfolio tracks the Russell 3000 index.
Cref sets no limits on the size of companies it invests in, though Cumming does point out that it takes an analyst just as long to develop a $5 mn investment idea as a $250 mn one. And since Cref managers sometimes take a stake of 5-10 per cent in a company when they see value, the result in practice is that there are few companies in the Cref portfolio capitalised at less than $500 mn. In the case of technology stocks, however, a package of smaller names and amounts are put together which add up to good sized positions in Cref portfolios.
Managing Cref’s mammoth assets begins with a board finance committee of 13, including TIAA-Cref’s chairman, two vice-chairmen and ten outside members from academia and the fund management industry. The finance committee delegates authority to the Cref investment committee, composed of four senior investment managers. It is the investment committee’s responsibility to manage the portfolios on a daily basis under the broad policy guidelines provided by the finance committee.
The finance committee does not dictate approved lists of stocks or investment policy. Rather, it is concerned with macro-economic issues, such as the degree of exposure in international securities targeted by Cref. One of the first pension funds to look overseas, Cref currently has a foreign exposure of about 17 per cent in its main Stock Account relative to a foreign investment target of 15 per cent. The finance committee also governs the types of investment products offered to its fund participants.
As for the investment committee, ‘We are differentiated by a bottom-up orientation,’ Cumming says. ‘Our analysts are combing the world for the best ideas, which the investment committee subjects to a real going over in terms of fundamentals and valuation. Then we take these ideas and plan portfolio construction in terms of sector and industry bets. The ideas bubble up and create a portfolio, which we then look at to make adjustments in certain exposures. But the starting point is always fundamentals of individual stocks.’
Some 60 professionals report to the investment committee on the Cref accounts. Of these, 19 are global analysts, following certain industries worldwide, while another 14 analysts and portfolio managers are devoted solely to overseas coverage. All work on the same floor of the New York office building, rather than in the locations in which they are investing. That means travel is important. Cumming describes the situation as a trade-off: the advantage of idea-sharing outweighs the disadvantage of working far away from local markets.
According to Cumming, Cref analysts are distinguished by their experience; even with the addition last year of ten junior analysts, the overall average time spent in the business is close to ten years. ‘We don’t think of our analysts as analysts in the traditional buy-side sense of the job,’ Cumming comments. ‘We regard them as industry or country managers because their job is more of a portfolio management func-tion – picking stocks that will outperform.’
Country managers, for instance, manage the international component of the different equity portfolios. The investment committee makes a overall allocation and country allocations for foreign markets, but it’s then up to the country managers to pick individual stocks. Cref’s general preference is for ordinary shares rather than depositary receipts, despite the stricter disclosure requirements met by ADRs, because the ordinaries tend to have better liquidity.
Carlton Martin, one of Cref’s senior global analysts, observes that while US disclosure standards are the world’s highest, Cref always looks for more information and clarity of detail from US companies. ‘Some companies just do a better job,’ says Martin. ‘One way of differentiating IR departments is by the information they supply beyond SEC requirements. We need more detailed information to make proper comparisons when making investment decisions. In overseas markets disclosure is improving and accelerating. There is a global race for US capital, forcing foreign companies to fulfil our high standards for information.’
Cref analysts’ stock picking abilities are honed primarily through experience. ‘The longer I’m in the business, the more sources I have,’ Martin says. ‘A Cref analyst keeps one ear to the ground, looks for changes in the economy, notes who the beneficiaries will be, looks at company valuation and studies return to shareholders over time. Then it is time to determine the capability of those running the company by meeting management and going on field trips to facilities.’
Mountains of sell-side brokerage research is available to Cref analysts, and a comparatively low valuation by Wall Street can mark a successful stock-pick, Martin says. He adds that over his career he has seen IR departments focus more and more on meeting shareholder needs. During that time, IROs have become more knowledgeable and top executives more available to explain the detail of their corporate strategy.
Responsible Investor
TIAA-Cref takes its social responsibilities seriously. It was one of the pioneers of the concept, evaluating and voting on proxies early in its history and helping to found the Investor Responsibility Research Centre in 1972.
But TIAA-Cref’s social objectives remain down-to-earth. ‘Our basic premise is that if a corporation is governed properly, its returns over time will be higher,’ says Cumming. Every investment is examined not only for financial soundness and prospects for earnings growth, but also for such factors as work and safety record, and compliance with safety regulations.
This goes hand-in-hand with the strong TIAA-Cref stance on corporate governance. As the array of shareholder proposals began to burgeon in the 1970s, TIAA-Cref was one of the first institutions to pressurise companies into action. The fund also established a special trustee committee on shareholder proposals to examine the individual merits of each case.
During the 1980s TIAA-Cref became widely recognised as a leader in corporate governance, focusing on areas such as management practices, performance and compensation. In 1987 the pension fund initiated its own shareholder resolutions for the first time, urging ten portfolio companies to review poison pills.
In 1988, the TIAA-Cref Trustee Committee on Corporate Governance and Social Responsibility was formed, composed entirely of outside members. The committee provides guidelines and decides on the voting of proxies, as well as initiating shareholder resolutions. Last year TIAA-Cref launched an expanded corporate assessment programme headed by Kenneth West, formerly chairman of Harris Bancorp. The programme increases Cref’s surveillance to all 2,300 US companies in its stock portfolios.
TIAA-Cref’s guidelines address matters like board diversity and independence; shareholder rights and proxy voting; compensation and performance evaluation; strategic planning; fiduciary oversight; and corporate social responsibility. In 1995 some 26 proposals were initiated covering ‘blank check’ preferred stock, secret ballot proxy voting and board diversity.
Cumming comments that the US boardroom is in better shape now than a decade ago, especially at larger companies. ‘There is still progress to be made with medium and small cap companies,’ he adds. In the last few years Cref, like other activist shareholders, has been negotiating with companies to try to bring change without recourse to proxy fights. In 1995, for example, 15 of its 26 proposals were withdrawn following dialogue with management.
For the politically correct pension planners, Cref introduced the Social Choice Account in 1990. The fund uses a variety of social criteria, or ‘screens’, to sift out certain companies. Currently, the portfolio does not invest in companies that produce nuclear energy, alcoholic beverages, tobacco products or weapons. Businesses that cause damage to the environment are uncovered with the assistance of consultant Kinder Lydenberg Domini & Co.
The Social Choice Account has done remarkably well in terms of performance, considering large S&P 500 companies had to be avoided. The portfolio’s average annual return since its inception is 13 per cent, with a respectable 29.5 per cent return over 1995. While Cumming is hesitant to characterise the effect of social screening on the portfolio as positive compared to the S&P 500, he states unequivocally that the effect is not negative.
Active World View
TIAA-Cref introduced the Cref Global Equities Account in mid-1992 as a broadly diversified portfolio of US and foreign stocks, heavily concentrated on the foreign element. The current target for the $3.3 bn portfolio is at least half the assets in foreign securities and at least a quarter in US securities, with some 65 per cent of total assets in equities.
Jeffrey Siegel, who began managing the Global Equities Account in 1994, describes the account as eclectic. ‘We have all different sizes and types of companies,’ he explains. ‘The portfolio is actively managed, seeking to invest in the world’s best companies with the best management.’ Siegel says this bottom-up approach often produces an uneven weighting compared to the benchmark Morgan Stanley Capital International World Index. ‘The index is used to measure performance, not to guide weighting,’ he explains. The portfolio showed a return of 20.09 per cent last year, compared to 14 per cent for the Lipper Index of Global Equities Mutual Funds.
One starting place for stock-picking is a database of 53,000 companies managed by Connecticut-based Factset. Cref analysts pore over growth rates, valuation and profitability ratios. The database’s flexible structure allows company data to be integrated into Cref’s own earnings models. Still, Siegel emphasises that he takes a mosaic approach to investment ideas, putting pieces together out of reading newspapers, magazines, and research reports, as well as continuing discussions with other portfolio managers and analysts.
Although the whole portfolio is actively managed, Siegel admits some investments aim to track the overall performance of certain markets. This helps reduce the risk in placing large bets on a relatively small number of companies. The portfolio has several hundred names but some 40 per cent – or $1.3 bn – is invested in just 40 companies. For these, Siegel says the most important requisite is an ability to know management and develop a long-term relationship built on trust and knowledge.
With this emphasis on management contact, Siegel covers more ground by delegating to two analysts who work with him. For instance, at a recent West Coast conference where 174 companies were gathered, Siegel and a colleague split up and each saw 50 companies – many of which were seen again in one-on-one meetings.
‘Great companies are not made overnight,’ Siegel muses. ‘Numbers are important, but management is the real story. I look for sound financial structures which give management the flexibility to pursue company goals, then make sure they know they have the financial backing to attain those goals.’
