Concerns about USS pension fund

by Dr. Ros Altmann

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John Plender’s timely article on the funding of University staff pensions (‘Failing the grade’ May 30) raises important issues for the pension industry.

USS is the latest example of an employer struggling with pension liabilities and hoping to avoid the economic realities associated with assuming open-ended, long-term commitments, which seem affordable in the cosy world of ‘expected’ investment returns.

When the going gets tough, employers are supposed to be there to put in extra money, so the criticism of the trustees’ decision not to demand increased employer contributions seems valid.  Surely, when deficits arise, is precisely when employers should be putting more in.

However, criticism of the decision to diversify asset allocation seems less appropriate.  Traditional over-reliance on equity investments, with no downside protection, was a flawed approach to matching pension liabilities over time.  There is little economic rationale expecting equity returns to keep up with salary inflation and longevity.  However, switching to bonds is not the answer for most funds.

Once in deficit, selling equities in favour of fixed income is likely to ‘lock in’ pension deficits or even make them worse, and also requires increased contributions to offset lower expected returns.

Surely, investing in high return-seeking assets other than equities makes sense, as long as the downside risk relative to liabilities is protected.  Using derivatives to insure against unexpected changes in interest rates and inflation can protect against a significant worsening of the deficit.  With this in place, there are many potential sources of investment return – both alpha and beta – allowing investors to benefit from market inefficiencies.  A diversified portfolio of hedge funds, currencies, unconstrained equities, real estate and private equity is likely to provide better, more consistent long-term returns than relying on equities to deliver all the added value. 

Combined with extra employer contributions where possible this approach should offer more promising strategies for trustees than relying on traditional asset classes alone.

Yours faithfully,

Dr. Ros Altmann

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