Private considerations
The way USS has developed its in-house private markets expertise over the past 18 years is held up as a case study in a report published by the People’s Pension.
The paper – Achieving critical mass – explores how workplace pension schemes might best approach investing in private markets. In doing so, it profiles our team in considering different models.
USS has had a team dedicated to investing in private markets since 2007. At 31 March 2024, we had
c.£25bn – or a third of the scheme’s total assets – invested in private investments across the world, of which, c.£11bn is invested in the UK.
The largest part of this (£8.4bn) was directly invested by our in-house team in private equities, including infrastructure businesses. A further £4.9bn was indirectly invested via private equity funds and co-investments.
Our private markets portfolio – also includes property (£4.2bn), and private credit and alternative income (£7.4bn).
Why private markets?
Private markets provide different opportunities from those available in public markets. Some, particularly in the case of infrastructure, are growth assets that may also provide long-term inflation-linked returns. These kinds of investments are well-aligned with the inflation-linked defined benefit (DB) pensions promised to our members.
They also support the diversification of our investments. Our private assets are part of the fabric of everyday life: housing, schools, health centres, retail and leisure facilities, motorway service stations, and even energy-efficient street lighting. We have more than £2bn invested in renewable energy and clean technology, including wind farms from the far north of Scotland to the south coast of Cornwall, which provide enough energy to light around 400,000 homes. We also invest in gas networks, toll roads, reusable pallet logistics, crematoria, and even a port.
Companies listed on a public stock market can be owned by thousands of disparate shareholders, and shares can be bought and sold almost instantly. With private markets, we have the opportunity to own a company if not outright then as one of just a handful of shareholders. And as a long-term investor, we can provide patient capital to support the long-term success of an asset. This can give us more direct engagement with a company’s management team and comparatively greater influence and/or clarity over its direction.
Performance
Our private investments have delivered strong returns over an extended period – significantly in excess of the performance of the scheme’s overall DB fund, which returned 5.8% per year (net of costs) over the 10 years to 31 March 2024.
Our private assets form part of our overall investment portfolio, which is routinely rebalanced to ensure it is aligned with the trustee’s risk appetite. In 2023/24, this saw us exit a number of private investments, generally at favourable prices to where they had previously been valued in our books, which allowed us to invest in other assets with strong long-term prospects.
Cost and value for money
A paper published by the Department for Work and Pensions (DWP) – Pension fund investment and the UK economy – included modelling of how different investment portfolios might impact outcomes.
The modelling recognises that private market assets are significantly more expensive to manage than other asset types (for instance, it assumed investment costs of 1% v 0.25% for public assets and assumed that private assets attract a 10% performance fee). Unsurprisingly, this impacts their comparative net performance in the modelling.
Even so, the analysis in the DWP paper still found that, on a risk-adjusted basis, a greater allocation to private markets produced "slightly greater expected returns through diversification benefits".
But, as noted elsewhere in the same paper, pension schemes with sufficient scale can manage these kinds of assets in-house and achieve significant cost savings compared with the fees charged by commercial, third-party investment managers (particularly in relation to performance fees which can make up a considerable portion of the returns achieved).
The People’s Pension paper also argues that developing professional direct internal private market management capabilities could reduce Master Trusts’ investment costs by several hundred million pounds a year.
And our experience bears this out.
We were able to introduce private market assets to the scheme’s default defined contribution (DC) fund* at no extra cost to members because we have a dedicated private markets investment team that already served the DB part of USS.
We manage more than 70% of the scheme’s total assets in-house. According to the latest independent analysis by CEM Benchmarking, the scheme’s investment management costs in calendar year 2022 were the equivalent of £121 million, or 35%, a year lower than the median global peer pension fund.
One of the biggest drivers of this cost advantage compared to our peers, is our private markets team.
*USS has been a hybrid DB/DC scheme since 2016. All members of USS are part of the Retirement Income Builder, the DB part. Around 190,000 USS members had supplementary DC savings in the Investment Builder part of USS at the end of March 2024.