As the UK's second-largest pension fund, with around £30 billion (€42 billion; $61 billion) under management, the Universities Superannuation Scheme (USS) has arrived surprisingly late at the private equity game. In fact, just a year ago, the scheme had no allocation to alternatives at all. Then it appointed Mike Powell as head of alternative assets in its London-based investment team (the organisation itself is headquartered in Liverpool). Suddenly, private equity was very much on the agenda.
Twelve months later, as he strides into USS' boardroom to meet with PEI, Powell is able to reflect on $3 billion of commitments made to a string of private equity funds since his appointment (see accompanying table). The firm now has a “medium-term” aim of committing 20 percent of its total capital to alternatives, with half of this accounted for by private equity and infrastructure. However, he stresses that this figure is an aspiration rather than a target and is “governed by the opportunity”.
As Powell takes a seat and pours himself a much-appreciated coffee (it is, after all, 6pm on a Friday evening when we meet), he reflects on the various challenges he has faced since he first arrived in his new surroundings following a ten-year spell at the Shell Pension Fund. It turns out that making the fund commitments has taken up a relatively small portion of his time. “Most of my focus has been on strategy, putting in place processes and raising awareness of the organisation. I've worn out a lot of shoe leather building our profile in the market,” he says.
USS is the principal pension scheme for UK universities, acting for 378 academic institutions with more than 230,000 members. According to Powell, “it has a positive cash inflow of around £1 billion per annum and strong growth is forecast in the university sector over the next ten years. That gives us a degree of comfort in making long-term investments.”
Long-term focus is clearly important to USS. In March 2006, it launched the so-called Marathon Club, an organisation which, according to its website (www.marathonclub.co.uk), is designed “to stimulate pension funds, endowments and other institutional investors and their agents to be more long term in their thinking and actions”. The group, which produces discussion documents and consultation papers, claims to have “approximately 18 members”.
Powell says he is keen to apply this philosophy to the construction of the firm's private equity portfolio. “A lot of investors in private equity started out without a formal process, invested ad hoc, and ended up with too many relationships as a result. What we're keen to do is identify key managers and relationships for the long term and make a meaningful commitment to them.”
BROAD OWNERSHIP PLEASE
Powell says he has formulated a fund rating system. Unsurprisingly, performance is the key criterion in determining the rating a fund is given. But “ownership and economics” are also important. Says Powell: “There is more instability within the ownership structure of fund managers as the industry matures and we have noted with interest the IPOs of management companies. We prefer GPs with a broad equity ownership.”
On the subject of fees, he adds: “We met with a couple of large GPs recently and they had a slightly different view on fees to us. The net return is the important thing, of course, but if the balance of terms and conditions is favourable to the GP we do take that into account. With fees that are not related to performance, such as deal and advisory fees, we at least want to know what the fees are. We push for as much disclosure as possible.”
The sceptical response at this point might be to question whether, as a newcomer to the asset class, USS can really afford to be too demanding. Powell admits that he had initial reservations about how warmly USS would be received by those GPs it wanted to support. “When I drew up the strategy, the primary risk I identified was our ability to access funds. But our access has exceeded our expectations.”
Asked why this might be the case, Powell refers back to the point about being prepared to stay the course: “We're not going to be in the asset class for two years and then pull out.” He also cites another, more idiosyncratic, reason. “They see our relationship with universities as providing added value. When we've asked for seats on GP advisory boards, we've usually got one – perhaps because being associated with universities is good for their reputation as we're seen as credible, responsible long-term investors.”
There is a lot more instability within fund managers as the industry matures and we have noted with interest the IPOs of management companies. We prefer GPs with a broad equity ownership
Aside from the university connection, there is another reason why the image of GPs might benefit from association with USS. The firm has the largest responsible investment (RI) team of any pension fund in the UK and is a signatory to the United Nations' Principles for Responsible Investment. Because the RI team integrates extra-financial issues into the firm's internal investment processes, any commitment made to a fund by USS is effectively an endorsement of that fund's policies in areas such as stakeholder accountability, environmental awareness and corporate governance.
Powell says he works particularly closely with the RI team when it comes to investments in the renewable energy space. “We currently have around $200 million invested in this segment and expect to make further commitments shortly,” he says.
Reflecting on the attitudes of the private equity industry as a whole towards responsible investing, he adds: “As an organisation, we don't want to endanger our responsible investing principles, but we feel private equity is generally consistent with them. Most funds are responsible investors – they just don't often state it explicitly,” says Powell.
The conversation turns to the Walker Report. With its focus on accountability and transparency, Powell views it as a highly significant document – even if he feels it would have benefitted from a better consultation process. “We felt there should have been more LP involvement at the outset to give the report more credibility. But we're very supportive of the conclusions of the Walker Report.”
USS: SELECTED FUNDS INVESTED IN TO DATE
|Buyouts||Secondary & Co-investment Funds|
|Apax Europe VII||Coller International Partners V|
|Bain Capital X||Lehman Brothers Co-Investment|
|Carlyle Partners V||Partners|
|Doughty Hanson & Co V|
|Warburg Pincus Private Equity X||Climate Change Capital Private Equity|
|Hg Renewable Power Partners|
|Impax New Energy Investors|
|Distressed debt & mezzanine||Other|
|MHR Institutional Partners III||Bridges CDV Fund II|
|OCM Opportunities Fund VII|
|WL Ross Recovery Fund IV|
|Goldman Sachs Mezzanine Partners V|
|Baring Asia Private Equity Fund IV|
|KKR Asian Fund|