USS shows enterprise in engagement

David Russell, co-head of Responsible Investment at the Universities Superannuation Scheme (USS), the £31bn (€46bn) second largest UK pension fund, explains how its SRI strategy is not just about risk but also reward.

Responible Investor: USS has a very developed system of engagement with companies. How does that operate and how do you measure success within that?
David Russell: USS engages with companies for a number of different reasons. One is to elicit information. A second is to elicit change within the company. A third is to get information that our portfolio managers use in their investment decisions. The results of those different types of engagement are sometimes difficult to judge.
Has the information been used in an investment decision? Well, we can ask the portfolio manager. Has the company changed? This is much more difficult to work out if it is the result of USS’ activities or of general engagement by other investors, NGOs or staff within the company itself. In terms of the access we get to senior management, because USS is relatively big shareholder in this market (UK) we do get very good access to the board, to the CEO, CIO and investor relations. In other markets where our shareholdings may be smaller,access is not so easy, but we tend to get access to senior management when we need it.
I think that over the last four to five years, the level of awareness of senior management in companies on corporate governance, environmental and social issues and other extra financial issues, has gone up and they are much more aware that long term investors like pension funds are very interested in these issues.
Responible Investor: Do you use class action lawsuits against companies involved in governance failures?
David Russell: USS does use class actions as part of the range of different tools we have for dealing with companies in which we invest. It’s a very useful tool in the US market which is used to dealing with class actions. But we also get access to investor relations and senior staff members where we wish to talk about certain issues. Board access is much more difficult in the US market compared to the UK and that is something we are working on currently.

USS is often approached by legal firms, particularly from the US, who are trying to get us, as shareholders in the companies they are targeting, to participate in class actions. USS tends to only participate in class actions where we believe that there is an opportunity for us to work with the company to change its governace structure and avoid issues happening again in the future.
Class actions are still relatively rare in the European market. USS has just participated in a settlement with Shell following its restatement of reserves a couple of years ago. This was a unique project led by Dutch pension funds under Dutch law whereby a settlement was reached with the company, as opposed to the more confrontational class action lawsuits that you see in the US.

Responible Investor: USS collaborates with a number of pension schemes worldwide on different topics. How do you decide what issues to look at and how does it work in practice.

David Russell: The types of collaborations that USS has been involved in enable other pension funds to participate at any point and we are very open to being approached by other pension funds and quite regularly are. Currently we are involved in a number of different collaborations on a range of issues including climate change through the Investor Group on Climate Change (IGCC). USS was also a signatory to the Carbon Disclosure Project (CDP) in its first iteration in 2002. We are also members of the Enhanced Analytics Initiative (EAI), which is encouraging the sell-side and other research providers to produce better longer term financial research. We are also members of the International Corporate Governance Network (ICGN) and Global Investor Governance Network (GIGN).We are funders of Pharma Futures, which looks at the pharamaceutical sector and its business model to look at how we as large investor can work with companies to make that business model sustainable.
Responible Investor: USS was involved a couple of years ago in the long-term mandate competition. Is that something that you employ now as a pension fund, and if not, why?

David Russell: The competition that we ran in 2003 led to quite a significant number of changes within USS. What we have done in the last year is that we have employed someone specifically to look after our alternative investment portfolio and within that we have significant investments which will give us much longer-term type investments.

Responible Investor: The fund recently announced it would be putting significant investment into alternative assets. How do you reconcile that with long-term fiduciary responsibility.
David Russell: USS has committed to put a significant portion of our assets into alternatives in the broader sense. Much of the money is currently going into private equity and infrastructure funds.
Responible Investor: Has private equity been an issue for you bearing in mind the recent criticisms of the industry?
David Russell: People have the view that private equity is a short-term investment strategy. But actually most private equity holdings tend to be longer term than most public equity holdings where I believe, for example, the rate of stock turn is a full turn every ten months, i.e. the full portfolio is turned over every ten months. Private

equity companies definitely hold on to their assets for longer than ten months.
Responible Investor: Do you think private equity managers have improvements to make in transparency?
David Russell: Private equity fund managers have realised that there is an issue with how they communicate their activities to both their investors and the market at large. Hopefully the outcome of the Walker consultation (UK review on private equity which reported in July) will lead to a much more transparent industry.
Responible Investor: USS has a large amount of assets in passive investments. Can you still engage with companies on that basis and do you ever engage with companies where you are underweight in your investment positions?
David Russell; USS’ view on passive investments is that because we cannot sell the companies we have a responsibility to be interested in how those companies are managed. So yes, we will engage with companies in our passive portfolio even if they are not held by our active fund managers.
Responible Investor: The fund has a number of investments overseas in emerging markets. Is that problematic for you as a pension fund in engaging with those companies?
David Russell USS is increasing its investments in alternative markets, particularly in South America, Asia and Eastern Europe. Access is an issue and there is far less information about the companies in those markets, particularly on governance and CSR issues, than you would see in developed markets.What USS tries to do is to work with people with local knowledge in those markets. In Asia, for example, we are members of ASrIA and the Asian Corporate Governance Association.

Responible Investor: You’ve been instrumental in the work of the EAI. What has it achieved so far and where has it encountered problems?

David Russell: We’ve seen a significant amount of research being developed by the mainstream sell-side and an increasingly large number of independent providers who are incorporating extra financial issues into their research. As well as the EAI we are encouraging the sell-side in this market to develop the research they are doing to cover corporate governance and environmental and social issues within their mainstream research.

Responible Investor: The EAI report which came out recently identified a number of areas where progress has not been so good. What were they?

David Russell: Undoubtedly the strongest area of the mainstream sell-side has been climate change and particularly the cost of carbon. Because carbon now has a price it has been much easier for the sell-side to incorporate that into their investment models, particularly for untilities and some of the really high impact sectors. What we are not seeing is research into more difficult areas: for example human capital management or M&A activity, wghere the the sell-side and independent providers are simply not providing that level of information.
I think that in the future we will see a broader

range of extra financial issues covered within in the sell side. I think that one of the issues is simply a lack of information from companies. Another is a lack of expertise in the sell-side itself. A number of the sell-side firms are tooling up and buying in information, expertise and building teams to help integrate these issues into their mainstream management. We’ve seen a number of the mainstream houses put resources in over the last two years. I think that will start to bear fruit as we go forward. What we have found is that some of the smaller research providers are able to produce research on M&A activity that some of the larger houses are unable to produce.

Responible Investor: As a fund you’ve been particularly active on issues of executive pay. Could you explain how and why?

David Russell: USS’ view on executive remuneration is that executives should be paid for their performance and that pay should be linked to the levels of returns that shareholder are receiving. Perhaps not surprisingly, in general terms, there has been an increase in the push-back from companies over issues where they feel they are being pressured on issues such as remuneration or CSR reporting.
As a shareholder in listed companies USS believes it is our responsibility to make sure that the executives in those companies are performing to their upmost and that their remuneration reflects that. As part of our voting process USS tries to write to the company where we vote against a resolution, whether it is remuneration or any other aspect of an AGM or an EGM prior to the event itself. This gives a company the opportunity to come back to us with additional information, which we can useto change our vote if we see necessary.

Responible Investor: The fund is also a signatory of the UN Principles for Responsible Investment. What do you think have been the successes of that?

David Russell USS believes that the PRI is an excellent project bringing asset owners and asset managers around the world together to a set of principles that we can all work to. The principles don’t demand anything of signatories but they give guidance and a direction of travel to those that sign up to them.

Responible Investor: USS has a very active membership and includes its own NGO within that. How does that change the way you operate as a fund.

David Russell For a number of years USS’ members have been actively interested in how the fund approaches its responsible investment activities. In 2004, we actually surveyed the membership and asked them about the approach we were taking such as engagement versus screening and the approach to dealing with some difficult issues. Most of the members who responded – and 10,000 did – were very supportive of the route that USS has taken.

Responible Investor: What areas of sustainable and new technologies has the fund been investing in?

David Russell: In terms of clean tech and renewable energy infrastructure, USS currently has £92m invested or committed to those sectors. I think as investors we have to be careful that we are not overpaying for the assets we are investing in. There is the possibility that many investments in clean tech at the moment could be overvalued and that could have an impact on long-term
returns. Having said that, USS is always looking for opportunities to invest in those areas. Responsible Investment is not just about looking at risk, it is about looking for upside as well.

Responible Investor: Can you explain the fund’s philosophy to responsible investment?
David Russell: USS’s responsible investment strategydoes not simply apply to our equity holdings, USS believes that within all our investments we should be responsible, which means we work with our property and private equity investment managers. I have to say that those areas are less developed than with our equity portfolios, but they are areas that we are working on.