UK - Universities Superannuation Scheme chief investment officer ROGER GRAY gives SEBASTIAN CHEEK an overview of the scheme's investment strategy
Sebastian Cheek: Could you start with a general review of the scheme's investment strategy?
Roger Gray: Well, USS is the second largest UK pension fund for the higher education sector in the UK. It has just under 400 participating institutions and has assets of £32bn, so it's a large fund. The fund is invested substantially with an in-house investment team and it is invested across a wide range of assets and strategies. Roughly speaking, 50% of the portfolio is in developed equities. The balance is in emerging market equities (about 7.5%), fixed income (about 17%), and the remainder in alternatives (about 15%) across a range of alternative assets and strategies and property.
SC: How is the investment team currently structured?
RG: The entirety of the London investment office is 90 members strong, but that will include both investment professionals and the control and support functions; investment risk, legal compliance, and operational activities to support them. The team is divided in terms of the public, or listed, securities activities. We have regional equities teams - the UK being the largest individual share of the assets run. Then we have Americas, developed Europe, ex-UK, Japan, Asia, ex-Japan developed. Then we have a global emerging markets activity. We have a fixed income activity looking at both global fixed income and UK fixed income. There is a property team divided with sector specialisations within the UK market, particularly looking at direct investment in property in the UK. And then the alternatives team can be divided between the liquid and illiquid portions. The liquid portion is absolute return funds (investments that we make); the illiquid (or the private market investments) spans private equity, private debt, infrastructure and such like.
SC: Some of your colleagues at other large UK pension funds have started managing third-party money. Is that something you might look to do in the future?
RG: Well, we certainly don't manage any third party money currently. The scheme is large enough to support teams across the range of activities that I've just described. One should never say never; there may be circumstances in which it makes sense for two like-minded institutions to pool together their assets, but we certainly haven't crossed that bridge yet. One area where we have made some crossing is engagement voting, or stewardship. There, in fact, collective action is often stronger and more effective and, indeed, cost effective, in the sense of sharing resource, than acting on a solo basis.
SC: A large chunk of your investments are managed in-house. How easy do you find it to attract investment management talent when competing with third-party managers?
RG: We have a very good team, and the team has been very stable, so those are empirical pieces of evidence suggesting that task has not been impossible. And behind that, obviously, is what people want to do in the environment in which they want to work. We're not out raising assets. We don't have a profit motivation; we have the motivation singularly of delivering the requirements of the Universities Superannuation Scheme. People who enjoy that long-term project - after all, the pension fund is a long-term undertaking - and that singleness of purpose, will find our environment hospitable and appropriate for them in terms of developing their career.
SC: USS is renowned for its environmental, social and governance issues. Can you tell me a bit more about how you've integrated that into your investment strategy?
RG: We have five professionals within our responsible investments team, and that team sits in the middle of our open floor and interacts with just about all the large investment teams. The business of engaging with companies is not something we see as being distinct from investing in companies. So they will participate in meetings alongside portfolio managers and, indeed, if there are materials and relevant governance issues or environmental issues or social issues, we want to have the full investment case, not just be fixated on current financials.
SC: Could you expand on how you're linking with other investors in terms of engagement? How are you boosting your influence over companies you invest in?
RG: That takes a few different forms. One is the large international collective action group - the UNPRI; we are a founder signatory of that. One of our trustees is on the board, and that has obviously now garnered a large number of major investors around the world to sign up to its principles. So that's on the very wide front. In terms of more narrow activities, we have got a voting and engagement alliance with Railpen, and that enables us to gain a bit of weight but also to use resource economically. We're also a member of a Japanese engagement consortium. We are operating across a wide range of geographies and we want to get as much mileage out of what we do as possible. There are numerous circumstances in which there are ad hoc groupings of likeminded institutions; so we have recently, with nine institutions, applied to the Cayman's regulator for some improvements in transparency in that jurisdiction. And that would be typical, there will be a number of instances in which we will team up on specific issues with a group of investors.
SC: USS is obviously leading the way there, but do you think UK pension funds generally are doing enough to engage in the companies that they invest in?
RG: UK pension funds generally, by number, are not huge [in their involvement]. I think the issue for all funds really is to ensure that the investment managers they use adhere to, and support in an active way, the Stewardship Code the UK has put in place. They should hold their managers to account for what they do, on a delegated basis, for the scheme.
SC: So is this something smaller funds can get involved with as well? You don't just have to be a big fund to push this agenda?
RG: Well, no - a smaller fund will have managers and they will select managers, and, we would suggest, should hold them to account in terms of how they perform the task assigned to them. Do they engage on the relevant issues with the investee companies held in the portfolio?
SC: What needs to change to ensure schemes truly act like the owners of their assets?
RG: The reality is that there is a free rider aspect. You don't have to do it yourself if you can count on a USS or a Hermes or someone else to do it for you. But we do believe governance, social and environmental issues are very important to the long-term success of the investments held collectively across pension funds. And ultimately, pension funds, as any member of society, are going to reap the harvest they sow.
SC: How is the scheme's alternatives programme following the difficult markets of 2008?
RG: Difficult markets affected all asset categories and a number of categories that were owned in the hope that they might be diversifiers - commodities for example, or indeed hedge funds - were subjected to stresses and performance issues during the financial crisis of 2008 and beginning of 2009. As we were in the build-up phase, I suppose that was to some extent a good thing for us. We were putting money into some strategies that have since performed extremely well - distressed debt would be a very good case in point. So in our lifecycle we didn't have a huge exposure in alternative assets and we've certainly found it helpful in some sense to be entering when others were either exiting or the competition for capacity was less great than it might have otherwise been.
SC: Do you have plans to increase the allocation to alternatives?
RG: Yes, the alternatives allocation is likely to reach 20%, or thereabouts, at some point in the next couple of years, and the issue then becomes not just do you have an alternatives allocation, but what is the disposition of that and how does that complement what you do across the rest of your fund? And clearly as an integrated fund we're looking for that to play a part in the asset allocation of the fund. So our hedge fund allocation is deliberately toned down in terms of exposure to equity market beta, as it is called. And, yes, we have an appetite - potentially a big one - for inflation plus long-dated return streams, which people refer to as being infrastructural utility-like streams. As long as we can access those, that would be a growing portion of what we do.
SC: Are there any other areas that you're looking to move into in the alternatives space?
RG: Well, there are certainly areas in the more esoteric end of alternatives where we are not presently particularly exposed, so insurance-linked strategies, intellectual property, etc. I think, given our scale and the desire to build up quite large blocks of money, we haven't really looked at the more fringe areas where the capacity is smaller but perhaps in the fullness of time that too will appear within our menu.
SC: And finally, what does the next 12 months or so have in store for the USS?
RG: As a market view, obviously it's very pleasing that the world has recovered from the financial crisis to a large extent as far as financial market valuation is concerned. However, that in itself raises some issues. Now that we've had this, what I'll call ‘normalisation' to some extent, what is the appropriate make-up of the risk that we carry in the scheme? It would be fair to say we emerged from the financial crisis a bit shaken as a fund. I fortunately arrived after that, but we have moved to diversify the asset allocations of the scheme. So 21 months after I arrived we actually have about 15% less in listed equities, even though it's still almost 60% of the scheme under that. So I expect some incremental further diversification of the scheme is likely to take place.
*This video first appeared on GP's suster title Professional Pensions
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