Top of the asset class

As the main pension fund for academic and senior non-academic staff of the UK universities, the Universities Superannuation Scheme (USS) has a lot of responsibility to bear. It is the second-largest pension fund in the country, and one of the largest investors in private equity, and currently has around £30bn of assets under management.

Recently backing both Warburg Pincus’ and Advent International’s latest offerings, the organisation is aiming in the medium term to raise its exposure to alternatives to 20% of total assets. However, in the absence of deals, it is proving difficult for many investors to meet their allocation targets as private equity firms have no need to raise any more money.

Here, Mike Powell, head of alternative assets at USS, speaks to EVCJ about how his organisation plans to cope during these lean times, how they decide on which fund managers to back, and what the private equity industry needs to be concerned about in the coming months and years.

What is the Universities Superannuation Scheme and how is the team there structured?

The Universities Superannuation Scheme is the principal pension fund for academic and senior non-academic staff of the UK universities sector. We manage around £30bn of assets and have a medium-term target allocation to alternatives of 20% of total assets.

We have around 30 investment professionals managing different asset classes but predominantly public equities. The alternatives team currently comprises six people covering private equity and infrastructure investments and we expect this number to increase to eight by the end of the year. We are also recruiting a hedge fund team of 4 people who will work closely with the private equity team. We maintain a very flat structure and have a single investment committee across alternatives for making investment decisions.

What is USS’s investment strategy?

Underpinning USS’s investment strategy is a commitment to long-term investing which we believe aligns closely to private equity as an asset class. Our strategy for private equity is to build a core of long-term relationship, with key managers in the different geographies and strategies. Around those core managers we will allocate capital to more opportunistic strategies and to managers who we believe can become core.

A key part of our strategy is an active co-investment programme to invest alongside our core managers. The willingness of managers to offer co-investments is a consideration in our manager selection process. We also look to build relationships with other like-minded institutional investors to explore opportunities to work together and potentially invest together.

How is your asset allocation split?

We don’t have specific target allocation to various strategies as we believe this can lead to sub-optimal investment decisions. We do have long-term guidelines, which reflect where we see the best long-term opportunities, subject to our risk, and return parameters. However, we try and retain flexibility to allocate capital opportunistically. Our current private equity portfolio has around a 50% allocation to buy-outs but has a significant allocation of 30% to special situations such as turnarounds, distressed debt and other debt-related strategies such as mezzanine. We currently have no exposure to venture capital.

Do you invest outside of the UK and Europe?

The intention is to have a global private equity programme and our programme already has around 50% of its commitment outside of Europe. US managers represent the majority of these commitments but we have two managers in Asia and expect to increase our exposure to this region over the medium term. Our investment strategy is long-term in nature and we try to allocate capital to where we believe the long-term opportunities will develop, as opposed to the size of the private equity market defined in terms of fund raising. For example, we are currently looking for managers in Japan as we believe there is significant long-term opportunity for the private equity industry to develop in that country.

Does USS invest directly into funds, via fund-of-funds, or both?

The vast majority of our investments will be directly into funds. The rationale for choosing this route is that a fund of our size can commit sufficient resources to our private equity programme such that we can build the in-house skills to select funds ourselves. This has a number of advantages. Firstly there is a significant cost saving by avoiding the extra layer of fund-of-fund fees. I also believe we can replicate the manager selection and access of fund-of-funds but at a much lower cost. We also believe that as a long-term investor, USS is more attractive as a limited partner than a fund-of-fund manager and as such we can secure better access to most general partners. The other benefit is that we have control over our portfolio construction and can better tailor the portfolio to meet our own objectives.

In some cases we will invest into fund-of-funds where I believe we currently have insufficient in-house resources or skills to address that market. For example, we committed to Constitution Capital Partners because we felt we could not manage a US mid-market mandate from our offices in London. Working with someone like Constitution gives us ‘eyes and ears’ on the ground in the US through a team with an established network of relationships in the US.

How do you decide on which fund managers to back?

We have a comprehensive due diligence process to select managers, which includes a mix of qualitative and quantitative investment, operational and legal and tax due diligence. An additional input into our decision-making comes from our responsible investment team who engage with our managers to better understand how they integrate environmental, social and governance factors into their processes.

Our investment due diligence focuses upon five key areas which are individually rated against set criteria to produce an overall fund rating. The five areas are historic investment performance which we see as the ultimate proof statement on the manager; general partner issues such as the experience of the team, remuneration of team and ownership structure; the strategy & investment process – for example the appropriateness of the strategy relative to the market opportunity; the fund terms – how well aligned are LP’s and GP’s interests, and lastly institutional sponsorship, which looks at the quality of the investor base and their alignment of interests of USS. We do put significant emphasis on past performance, as unlike public equities managers we believe that past performance is a guide to future performance in private equity.

To assess managers on this basis we do a significant amount of off-site quantitative and qualitative performance and organisational analysis, which creates a number of issues that need to be discussed with the prospective manager. To do this, we undertake on-site due diligence visits to managers to at least one of their offices and often to two or more. These visits usually last a day and involve at least two of the USS private equity team and we try and see as many of the manager’s team as possible, at all different levels of seniority. We also undertake a significant amount of reference calls to either confirm or challenge our own analysis and trigger additional due diligence if necessary. Ultimately, private equity is a people business so our personal interactions with the team play a large part in our decision-making although it’s not explicitly assessed like the other factors.

How much contact do you have with your GPs and what form of contact does this take? Are you satisfied with the investor relations departments at your GPs and in what areas do you think IR needs improving across the private equity industry as a whole?

I believe in developing strong relationships with our GPs given the long-term nature of the relationship and the “blind-pool” structure. Our contact takes a number of forms. We routinely take seats on investor advisory committees as a means of building relationships as well as gaining additional oversight on the manager. We also look to co-invest with managers as I believe this is an excellent way to get to know a manager and how they approach investments. We also regularly meet our GPs on a more informal basis, particularly out of the fund raising period or at annual meetings when they are more relaxed and open.

Generally we are satisfied with our GP relations but improvements can always be made. I believe transparency is still an issue with some managers, which needs to be improved. The introduction of FASB 157 also requires more pro-active communication by the GP to explain how they are valuing portfolio companies.

Venture capital is a bit of a maligned area in Europe – what is your opinion on this asset class?

We have only assessed venture capital at a macro level and currently we have decided not to invest in any venture capital. Our main concern is sufficient access to top-decile managers. The dispersion of returns in venture is even more pronounced than buyouts, making it crucial to access those top managers and in sufficient size to generate the required returns at the total portfolio level.

We will continue to revisit our strategy on venture and I don’t rule out making investments in the future.

In light of the economic downturn, how do you think the private equity industry will cope? Are you looking at alternative asset classes as a result and are you preparing for lower vintages?

I believe it’s inevitable that a large private equity-backed company will fail in this cycle and that the unsustainably high returns of recent vintages will decline. However, I still expect private equity to generate a significant premium to public equities to more than offset the additional risk. I also believe that previous periods of financial and economic distress have often produced the best vintage year returns and we expect this, to a degree, to hold true. The only caveat to add is that the amount of capital raised during this period is substantial compared to previous periods of market distress, which may moderate comparative returns.

Our strategy for private equity has always been to be opportunistic and remain flexible in terms of how we deploy capital. We have stayed true to this strategy and allocated a significant amount of our commitments to special situations, distressed debt and other debt-related strategies such as mezzanine debt and senior bank loans. I believe that one of the key strengths of private equity and pension funds like USS is that we are long-term investors and as such can take contrarian views when justified.

Last year the private equity industry took quite a battering from trade unions and the media. What was your take on this and what can private equity do to improve its image?

Once private equity firms started looking at household names such as Alliance Boots and Sainsbury’s then a higher degree of public scrutiny was a natural consequence and the private equity industry should have been better prepared to defend itself. That said, the nature of some of the criticism and how it was conducted was unacceptable. I believe that the private equity industry has nothing to hide and in the vast majority of cases has a positive message to tell. The Walker Report was a step in the right direction. USS was an active participant in providing input for the report and we supported the recommendations. Private equity now needs to build upon this first step and continue to embrace transparency in all its activities. However, the private equity model has some clear advantages over public ownership and any further initiatives should be careful not to undermine the strength of that model.

What issues do you think the private equity industry needs to be most wary about in the future?

I expect that a large leveraged buyout will inevitably fail during this cycle and the private equity industry needs to be prepared to deal with the fallout particularly on public and political opinion.

The other key issue for the industry is the continued process of institutionalisation. This is a natural stage in the evolution of the industry but it needs to be carefully managed so as not to undermine its core attributes, particularly the focus on generating absolute returns and not accumulating assets solely to generate fees.

What does the future hold for USS?

USS will continue to grow its alternative asset programme and exploit its position as a long-term provider of capital. We intend to become an active co-investor alongside our GPs and other alternative managers and will continue to look to form alliances with other like-minded institutional investors to capitalise on investment opportunities.

One of the core aims of the alternatives programme is to exploit synergies across all the asset classes managed by USS. Looking forward, we expect to see opportunities to apply certain aspects of the private equity model to our own management of public equities and similarly we see the potential to capitalise on our position as a major UK public equities shareholder to work with our alternative asset managers.


Universities Superannuation Scheme (USS)

USS is the second-largest pension fund in the United Kingdom and the principal pension scheme for UK universities, acting for 378 universities and academic institutions. It has more than £30bn in assets, and approximately 250,000 members, and has a commitment to long-term and active share ownership. USS has initiated and participates in a number of collaborative public equity investor projects covering issues as diverse as climate change and the Pharma business model, to US corporate governance and executive remuneration. USS currently has approximately 5% of its assets allocated to alternative investments, with a target to grow this allocation to 20% over the medium term. Within alternative investments, USS has made sizeable commitments to private equity fund managers and is also making investments directly into private equity transactions.


Mike Powell

Mike Powell joined USS in September 2006 as head of alternative assets to build the alternatives investment programme. USS is targeting 20% of total assets over the medium term. Prior to joining USS, he spent the majority of his career at Shell Pensions Management Services Limited in a variety of investment roles, latterly as head of strategy. He is a member of a number of investor advisory committees for private equity and infrastructure funds. He graduated with a first class honours degree in Economics from Warwick University and is an Associate member of the UK Society of Investment Professionals (UKSIP).