For more information contact: emailus@marcusevans.com Roger Gray, the Chief Investment Officer at USS Ltd. shared his presentation entitled "Implementing a Long-Term Investment Philosophy" at the European Pensions and Investment Summit. Join the 2015 Summit along with leading regional pension investors and global asset managers in an intimate environment for a focused discussion of key new drivers shaping institutional investment strategies today. For more information contact: emailus@marcusevans.com

1. European Pensions and Investment Summit 2012
IMPLEMENTING A LONG-TERM INVESTMENT
PHILOSOPHY
Roger Gray
Chief Investment Officer, USS Ltd.
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2. • USS
• How to be a long-term investor
• Current conditions
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3. USS
• Open DB pension scheme since 1974
– 400 UK universities, higher education and research
institutions
– 285,000 members: 50% active, 30% deferred, 20%
pensioners
– Assets: £33bn (€40bn)
• Target SAA
Equities 50%
Alternatives 21%
Property 9%
Bonds 20%
• Largely internally managed: investment office of 95
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4. Strategic Asset Allocation
• Managing twin objectives
– Required contribution rate
– Volatility of required contributions
• SAA has become more balanced
– Reducing risk concentrations
• Potential addition of liability hedging overlay
– A liability-matched target state
– Current market yields in long-term perspective
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5. Gilt Yields – Nominal & Index-Linked
10
Latest Yields (as of 14 May 2012)
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Nominal 3.2%
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Index-Linked -0.1%
7
6
Bond Yield %
5
4
3
2
1
0
-1
UK 30-Year Nominal UK 30-Year Inflation-Linked
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6. Diversification: Implementation
• From low-cost model …
– In-house manager: Equities, Govt Bonds, Property
– Passive-like costs, some alpha
• ... to cost-effective customised solution
– Wider range of activities
– Alternatives team; delegated manager fees
– Dynamic asset allocation and A-L risk management
– Greater operational demands
– Increased regulatory scrutiny
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7. Diversification: Governance
• Clarification of Delegations
– Board, Committees, Executive
• Additional Specialist Expertise
• Investment Company Subsidiary
– Professional board: executive and non-executive
– Comprehensive investment management agreement
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8. • USS
• How to be a long-term investor
• Current conditions
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9. Characteristic Traits
INVESTORS: Short-Term Long-Term
LIABILITIES Short-term Long-term
CASH-FLOW Negative Positive
TURNOVER High (Trading) Low (Stewardship)
RISK Volatility Sustained loss or shortfall
FORECASTS New, direction, technicals Risk premia, inefficiencies
ILLIQUIDITY Low tolerance High(er) tolerance
MANAGER
TENURE Short Long
ASSESSMENT Performance... Process/People...
INCENTIVES Short-term Long-term
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10. Managers: Internal or External
Internal External
ALIGNMENT Career Relationship vs. Transaction?
INCENTIVES Long-term alpha Benchmarks: Beta vs. Alpha?
Risk-adjusted, after-cost Short vs. Long-term?
Collective and individual Luck vs. Skill?
GOAL Return maximisation Profit maximisation
FOCUS Investment Asset gathering vs. capacity?
TRANSPARENCY Visibility, control & risk mgt. Integrated/superior reporting?
COST Scale: basis point per AUM? Profit goal, business expense
CAPABILITIES Incomplete, inferior, robust? Accessing best managers?
TIMELINESS Build investment/operations? Selection and due diligence
RISK BUDGET Concentration? Governance burden
ALLOCATIONS Permanent Occasional
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11. Required Risk, Desired Risk
Risk-Taking Capacity Risk Tolerance
• Funding Ratio • Contribution Minimisation
• Strength of Covenant versus
• Duration of Liabilities • Acceptable volatility of
• Maturity of the Scheme contribution rate
(projected cash flow) • Regulator’s Tolerance
• Risk-Sharing – recovery period
(benefits + contributions) – return assumptions
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12. Sustainable Investment Policies
• Working within your boundaries
– Tolerable contribution rate and funding ratio?
– Acceptable recovery period?
– Reasonable asset performance assumptions?
– Scope for sharing risks and benefits?
• Covenant, fund rules, actuary, regulator, human factors
... Long-term investment based on acceptable risk
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13. DAA and Long-Horizon Investing
• DAA: When to take what and how much risk?
– Absolute and relative value
– Time-varying risk premia
• Equity
• Credit
• Illiquidity
• Insurance
• Long horizon stabilises required rate of return
... The comfort of long-term confidence cones
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14. Confidence Intervals & Risk Tolerance
250
Liabilities + 3%
Assumes:
Sharpe Ratio = 0.25
Liabilities + 2%
Initial Funding Level = 85%
Liabilities + 1%
200
150
Funding Ratio
100
50
0
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15. • USS
• How to be a long-term investor
• Current conditions
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16. Taking Risk … if you can
• Systemic capacity shortages for
– Taking Risk
– Providing Liquidity
– Bearing Complexity
• Tension between our Twin Objectives
– Investment Returns: keep contributions ‘affordable’
– Limiting Risk: avoid (much) higher contributions
... heightened by low funding ratio
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17. Some Post-Crisis Issues for SAA
• Instantaneous vs. long-term risk and return
– e.g. Term structure distortion
– Playing ‘safe’ can add risk and make you poorer
• Hedge funds: mix your own
• Commodities: of super-cycles and 1-month futures
• Risks of pro-cyclical risk models
• What data set?
– Example of optimal currency hedging:
• With or without 2008
• Asset-liability context
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18. Optimal FX hedging
Full data set: Excluding H2 2008:
11.0% 11.0%
11.0%
Annualised Monthly Vol
Annualised Monthly Vol
10.9%
11.0%
10.9%
10.8%
10.9%
10.7% 10.9%
0% 20% 40% 60% 80% 100% 0% 20% 40% 60% 80% 100%
FX Hedge Ratio FX Hedge Ratio
2.2 Dollar 300
2.0 Euro
Yen 250
Dollar & Euro
1.8
Yen
1.6 200
1.4
150
1.2
1.0 100
1999 2000 2002 2004 2006 2008 2010
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19. Investment Conclusions
• Assets serve liabilities
• The ERP is dead, long live the ERP
– Expected rewards for bearers of systematic risk
• Too much of a good thing
– Is policy sustainable? What to do if ‘worst case’ scenario?
– Diversification of factor risk
• Contrarianism at extremes
– Can you buy/hold in stressed markets?
– Can you defer return-seeking in complacent markets?
– Can you afford not to?
– Regulatory regime, horizon, covenant strength, human factors
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20. European Pensions and Investment Summit 2012
IMPLEMENTING A LONG-TERM INVESTMENT PHILOSOPHY
Roger Gray
Chief Investment Officer, USS Ltd.
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