(updated with correction)
Roger Gray has seen the pension industry from all angles — as a money manager, consultant and chief investment officer of Britain's largest corporate pension fund. Now he's taken the helm as CIO of the £26.8 billion ($44.7 billion) Universities Superannuation Scheme, Liverpool, England.
Educated both in England and the United States, he worked for money managers, including UBS Global Asset Management and Rothschild Asset Management, before setting up as an independent institutional investment adviser. After four years as a consultant, he was recruited in 2006 by Mark Anson — then CEO at Hermes Pensions Management Ltd. — to become CIO of the group, which manages the £30.4 billion London-based BT Pension Scheme.
As Hermes morphed into more of a multiboutique business model, Mr. Gray decided to jump ship to USS, one of Britain's few defined benefit pension funds that's still open to new members. He arrived in September at a critical time for the fund. As with many of its peers, the fund's dependence on public equity — which comprises about 72% of total assets — spelled disaster in the year ended March 31, when its funding level dropped to 74% from 103%.
Officials began an overhaul of the investment strategy in the past year, targeting a 20% allocation to alternatives from the current 8%, primarily at the expense of public equities. While others are moving assets into passive management, the fund is building its active portfolio.
What do you see as your biggest challenges? USS is an open DB scheme. It's relatively immature — about 50% of the members are still active. The fund is still growing and has quite a long duration profile. In that context, asset allocation of the scheme is heavily weighted toward return-seeking assets dominated by public equities. The challenge facing the scheme is to move to a somewhat more liability-aware stance and a more diversified asset allocation. To do that in judicious quantities at well-chosen moments will be challenging. The build-up in alternative assets is an important part of the process to reduce the heavy concentration on public equities. It's easier to be contemplating that move out of public equity now than it would have been nine months ago. Though wearing the hat of a strategist, it's harder to say what's going to happen in the next few months maybe than it looked at the height of the crisis.
How do you plan to develop the alternatives portfolio? Private equity and infrastructure together make up about 7% (of total assets) and that's invested with reasonably significant commitments ahead. That's a relatively advanced part of the alternatives program. Over the last year, we've assembled our hedge fund team and are in pretty early stages of making hedge fund allocations. We've allocated to two hedge funds, and we're aiming (to invest in) about 30. We've still got some ways to go. We're starting from below 1% and targeting a 5% allocation to hedge funds, representing quite a lot of money to be deployed prospectively in that area. The other parts of the alternatives program — commodities, timber or exotics — are smaller and not terribly developed at this point. Exotics would be considered at a later stage.
What do you see as interesting opportunities in hedge funds? We have a passive core strategy, which uses a replication approach. Our core active strategy is just getting under way. Because we're aiming to diversify against a very large exposure to public equities, we're looking for low-beta strategies such as macro, CTA (commodity trading advisers) or long-short equity strategies ... We're focusing on putting in the core elements at the moment. In terms of tactical allocations, at the start of this year, there was considerable interest in long-credit-oriented funds to access that remarkable credit opportunity that was presented. There has been quite a normalization, so if we were tactically interested in credit hedge funds at the moment, it would be much more opportunistic and probably even short-oriented funds ... funds that are capable of taking an anti-credit view as much as a pro-credit view.
Are there any plans to manage more assets in-house? We already have a relatively low level (about 28% of the portfolio) of external management. If we take on even more asset classes to manage actively in-house, it would be difficult to see the economic benefits of building the capability to manage all of these in house. ... If you look at the sort of areas in which we are not active, for example, we're not active in corporate debt and mortgage debt internally ... These are going to be areas where we may make allocations but then rely on other managers. ... By building the alternatives portfolio, we're building external management ... we expect that (the portion of external actively managed assets) could be about a third (of the total active investment portfolio) compared to about 20% currently.
In focusing on active management, is USS moving against the industry trend toward passive? There is a shift here from beta-dominated risks to getting more alpha into the equation. There is diversification benefit in seeking more returns from alpha rather than depending so heavily on the returns from the equity risk premium alone. Obviously there's a spectrum of management styles, so parts of the scheme are managed less actively than others. But we certainly don't have any intention to build up pure passive at this point.
The benefits of diversification have been severely challenged. Have you revised your own approach to diversification? There's always room to learn; that's lesson No. 1. There were particular features of the crisis which resulted in higher degrees of correlation than most people had anticipated, particularly in 2008 ... That correlations rise in a stressed environment is not a total surprise, but the benefits of diversification are probably not disproven by one episode. We'll learn something about the factors that drive performance and about trying to get a better blend of factor exposures as a result. Diversification is not a perfect tool, but it's clearly better than doing nothing ... the alternative is a perilous route. The preference is to have something which makes sense when seen from a number of different angles, rather than something which looks perfect from only one viewpoint.
What investment mistakes have you made and what did you learn from them? Mistakes are great teachers. They're often expensive teachers, but you do get something if you think them through. A value-oriented investor or value-aware investor will tend to, on occasion, be early — not necessarily wrong, but early. I've certainly been there in a few instances: I was anti-dollar in 1984 and had to wait until 1985 when that turned; I was anti-Japanese equities in the late '80s and had to wait pretty much until the end of that decade before that was vindicated; most recently, I turned positive on risk assets in the fourth quarter of 2008. Each of these things turned out all right in the end, but were painful to endure. The lessons are to calibrate positions so as not to have an unsustainable concentration (of the portfolio) and to establish the right relationship between client, manager and, where applicable, consultant. Otherwise, you can get forced into a reversal of positions, which can be the worst outcome.
