Magazine Issues » May 2010


Roger Gray, CIO of the USS pension fund for the past seven months, talks to Angele Spiteri Paris about hedge funds, missed opportunities and strengthening 'middle ground' processes.

Roger_GrayThe Universities Superannuation Scheme (USS) is one of the UK’s largest pension schemes with £27bn (€30bn) in assets under management. The scheme’s portfolio is not exactly what would be expected of UK pension schemes, which are generally seen as conservative in their investment approach. But in recent times USS has been on the vanguard of investment trends.

Roger Gray, chief investment officer, says: “From an asset allocation point of view, we look quite different from many pension funds. But we’re not a completely different species.”

Having said that, USS has been gutsy, for example, in its approach to alternatives. But being a large pension scheme, the fund has had trouble trying to take full advantage of market opportunities, which is something Gray is trying to rectify.

Distress raid
The distressed assets available post crisis meant that cash-rich investors could clean up – buying fundamentally sound assets for bargain prices.

Gray says that the fund had limited scope to capitalise on this opportunity. “One of the lessons we learnt from the crisis was that although we were minded to capitalise on the distressed opportunities, we were not very well placed to do this. We had such a return-seeking asset allocation already that we could only add incrementally on a smaller scale than the opportunity warranted.

“In future we hope to be better positioned to take advantage of such opportunities when they come about,” he says.

One thing Gray says can be done is to strengthen what he calls ‘middle-ground’ processes ­– or assessments that fall somewhere between strategic and tactical decisions.

“Lessons taught by the crisis were not just about market behaviour. Another important one has to do with governance. It’s about putting in place the preparatives to be able to respond to a crisis or opportunity,” he says.

It’s about having a contingency plan.

Gray says: “USS is well positioned on the tactical end with our internal investment management team, but there are some operating processes that need to be
worked on.

“For example, we have a strategic asset allocation process that goes to the board for periodic approval. This sets benchmark allocations or target allocations to be built up.  For target allocations, there is guidance on the time frame but with elements of flexibility.

“So, when our board decided that we would invest 20% of the fund into alternatives, how the progress of that allocation is implemented and monitored then fell into this middle ground.”

Gray says another such process is what happens to the fund’s strategic asset allocation if there is a material change in the world.

“It’s about medium-term asset allocation really, which we’ll be working on. We need processes to be able to respond if necessary. For example, if the funding ratio improves we can afford to have more liability-hedging assets in our portfolio.”

At present, the fund has not pursued liability hedging with the same fervour that some other UK pension funds have shown.

Gray says: “Pure liability-hedging assets, such as index-linked gilts, tend to be ­– and currently are – very expensive. This is a deterent to giving up return-seeking assets in favour of risk-reducing assets. We’re not going down the liability-hedging route as aggressively as some others have done. We will do some liability matching, but not as much. As a relatively immature scheme, we don’t envisage being an immunised fund, but we will reduce the asset-liability volatility progressively over time.”

Alternative view
It’s clear that hunting alpha and generating returns is an important objective for USS. And crisis or no crisis, the fund has not strayed from its project of allocating more assets to alternatives.

The last few years may have given hedge funds a bad name, but Gray is not spooked by the bad reputation these vehicles have amassed. He is confidently rolling out the fund plan to invest in a total of 30 single-strategy hedge funds.

In 2007, the fund’s board of trustees launched an investment programme to invest 20% of its £23bn portfolio into alternatives. The programme was initially focused on alternative asset classes such as private equity and infrastructure and USS had already deployed around half of the assets by June 2009.

Gray says: “Hedge funds are the most rapidly growing part of the alternative programme at present. Since last autumn, we’ve been hiring about one hedge fund manager per month and expect to continue to do so for the next couple of years.

“We currently have six hedge fund managers and are looking to have about 30 in total. We expect to have over 5% of the fund invested across individual hedge fund strategies.”

Most recently, the fund awarded a $1bn (€740m) mandate to Man Group, the UK hedge fund manager, to run on its managed account platform. Responsibility for manager selection will remain with USS.

Asked whether the upheavals within the hedge fund industry were any cause for concern, Gray says: “Hedge funds have flexibility in structuring their active risk in the portfolio which helps them to get the best out of the universe of investment opportunities.

“Doubtless some holdings are going to look unattractive at particular points in time, but we have limited long credit and equity exposure in the hedge funds we invest in so we don’t feel exposed to extreme left-side tail risk.”

He explains that, being a long term investor, a fund like USS can withstand a certain level of illiquidity and in this regard there is an upside to the crisis.

According to Gray: “Before the crisis, the premium paid for illiquidity was inadequate. This premium picked up in the crisis. Now we think we’re still being well compensated for a certain degree of illiquidity.”

Good times
Gray has been CIO of USS for around seven months, replacing Peter Moon, who retired after 17 years with the fund. Gray says: “The market has been fantastic over the last seven months since I’ve been here. But the previous two years were very testing indeed. The decline in assets versus liability valuations was extreme and the fund wasn’t exactly the most diversified of asset pools – there was a high concentration of equity assets within the portfolio.

“Having said that, even investors who thought they had a well-diversified range of assets saw a painful mismatch between their liabilities and the performance of their investments.”

The fund’s annual report for the financial year ending March 2009 showed that its investments fell by 27.2% against the benchmark fall of 25.7% in 2008 and continued to fall until 31 March 2009.

Over the past five years the fund has returned 3.1% per annum against a benchmark return of 4% and, over ten years, 2.3% against a benchmark of 3.3%. The total value of the fund fell from £32.6bn at the end of December 2007 to £23.1bn at the end of December 2008. Further adverse market movements reduced this value to £21.4bn by 31 March 2009.

But since then fund performance has significantly improved. Gray says: “I don’t think the scheme will have a better year than the financial year just ended – the next set of results will be very different from those released in March 2009.”

The results for fund performance until March 2010 are due out later this year, but after a difficult start to 2009, the fund returned 19.4% for the year. The fund is estimated to have made further gains of near 5% in the first quarter of 2010 – taking the fund value to around £29.8bn.

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