The UK’s largest pension fund, USS, is going to spend more of its energy in engagement with government and corporates than producing emissions reports.

Between 2019 and 2023 University Superannuation Scheme, USS, the £78 billion pension fund for employees in the United Kingdom’s university and higher education sector reduced the carbon footprint of its portfolio by 35 per cent.

Well-documented strategies include tilts to climate-friendly assets, reduced exposure to companies that are poorly positioned to adapt, and direct investments in renewables, all carefully backstopped by the complex and time-consuming process of measuring and reporting emissions across the portfolio.

Yet global emissions have climbed relentlessly higher.

In an interview with Top1000funds.com, CEO of USS Simon Pilcher says the carbon reporting burden is distracting from more useful strategies like engagement to encourage others to act as long-term players. USS will continue to measure its carbon emissions and plans to produce at TCFD report this year. But going forward the investor will spend more of its energy in engagement with government and corporates than producing reports.

“Our portfolio has decarbonised significantly, but to put it bluntly, it’s not made a jot of difference in the real world and our focus is on a real-world impact rather than window dressing of our own portfolio,” says Pilcher.

Time to step up the pressure

USS’s decision to divert time spent reporting to ratcheting up pressure on policymakers coincides with the link between carbon, temperature rises, and extreme weather becoming one of the most worrying and urgent investment themes for the universal owner and long-term investor.

Pilcher says a hot world in 20 to 30-years- time will result in “horrible returns” for pension funds that own small slices of everything and are unable to sidestep or diversify a way around. “All assets will struggle in a four degrees world, and we have realised in the last 12-18 months that we need to seek to influence not just the stocks we choose, but the environment in which we all operate.”

Policy change is a precursor to meaningful corporate change and USS wants to help create a landscape and economic framework within which corporates and consumers can choose lower carbon options. It’s not worth expending energy trying to persuade companies to do the right thing when the economic incentives remain so strong to continue to do the wrong thing, Pilcher continues.

“We encourage long term approaches, but it is daft to ask companies to do things that make little economic sense as they won’t do it. We need an environment where it makes economic sense to do sensible things, and one that removes the financial barriers to doing sensible things.”

Pilcher turns to the barriers USS has met battling to green one of its own infrastructure assets to illustrate how the UK’s planning system actively encourages companies to do the wrong thing.

The UK needs more electric vehicle charging infrastructure if the country is going to successfully increase uptake of electric cars. Yet there is currently a 10-12 year wait to get green power to motorway services like USS-owned Moto, the country’s largest motorway service station network. “We need a planning regime that will speed up the connection of offshore wind to the grid and the delivery of electricity to where it is needed.”

Elsewhere he points to energised colleagues who want to install air source heat pumps in their home but have given up because local authority planning makes it impossible.

Will they listen?

Pilcher reports a strong willingness from the government to listen and an understanding amongst policy makers of the need for long term investors to have policy certainty to deliver long term and sustainable benefits. Describing the conversations as constructive, sensible and calm, he says the government grasps that open pension schemes like USS offer real scale and draw international investors interested in partnering with them to the UK.

“Asset owners like USS don’t have much control but can and should talk to and encourage policymakers to create a landscape and economic framework within which corporates and consumers can choose lower carbon options. It may have got harder in North America, but that doesn’t mean the rest of us shouldn’t continue to speak calmly on this issue.”

However, he’s under no illusions that the absence of long term thinking makes achieving change difficult. Politicians are focused on four-to-five year re-election cycles which are now backdropped by geopolitical uncertainty and the prevalence of more extreme political positions in the US and across Europe that would not have been popular 20 years ago.

Corporates and asset managers are similarly focused on the short-term. Corporate management turns over every 5-10 years and companies are reluctant to take actions that will cost them money and risk shareholder discontent. Investment managers are also focused on making short-term profits, he says.

That lack of alignment with asset managers is one reason USS manages over three quarters of its assets internally. Managing assets internally allows for a clarity of investment strategy that is hard to replicate via a third-party mandate, he says. “We are not interested in market indices. We are interested in assets that meet our needs.”

It is also materially cheaper to manage private assets in house.

Around 10 per cent of the allocation to private assets is managed externally yet that 10 per cent allocation costs the same as it does managing the other 90 per cent of the portfolio – not only the other 20 per cent invested in private assets that are managed internally, but all the public assets in the portfolio, some of which are also externally managed.

“It gives you a feel for how much better value it is to do it in house,” he says, “When we look at the value to our members, we think our model is strongly aligned to our members needs.”

Testimony to his belief in internal management, USS will build out the 75-person investment team with another ten hires over the next three years. He has no plans to build out the allocation to private markets any further.

Pilcher says the portfolio is prepared for the shift in trade flows and end of “peak trade,” and has gradually moved to reflect this long-term structural reality to protect the portfolio. Last year the fund increased levels of inflation protection in the scheme by buying inflation linked bonds in the UK and US. Meanwhile higher interest rates have helped USS swing from deficit into a £9 billion surplus.

South Korea state pension fund National Pension Service (NPS) has delivered a new return record in 2024 driven by US tech stocks’ relentless rally, while its investments in global fixed income and alternatives also posted double-digit returns.  

This year, the world’s third-largest pension fund is gearing up to reduce coal investments to promote sustainability in the portfolio, and target riskier assets to ensure sustainability in funding.  

NPS announced a 15 per cent return on a money-weighted basis in 2024, which was its best-ever performance since it was established in 1988, according to a press statement. The gain brings NPS’ total assets under management to 1213 trillion won (KRW) ($842 billion).   

The fund’s last record return was set as recently as 2023, and it has only had two years of negative return since inception. It invested almost exclusively in fixed income before 2000.

NPS chair and CEO Kim Tae-hyun highlighted the fund’s ability to achieve two consecutive record returns despite uncertainties in local and global politics, and concerns around economic slowdown.

“We will continue to closely manage risks and bolster our investment capability and expertise by implementing the Reference Portfolio and the Next Generation Global Investment Integration System, as well as by attracting local talents, in a bid to deliver solid returns in the years to come,” he said in a statement. 

The global equity portfolio was worth KRW431 trillion at the end of 2024 and represented 35.5 per cent of the portfolio, according to a disclosure. It delivered a 34.3 per cent money-weighted return but was somewhat offset by weak performance in domestic equity which lost 6.9 per cent.  

Political uncertainty was one of the reasons cited for negative returns in domestic equity. South Korea is in flux as the nation waits for the court verdict in President Yoon Suk Yeol’s impeachment trial, which could be delivered as early as this week. It came after Yoon unexpectedly declared martial law in December last year, which resulted in nationwide protests and stoked volatility in the local equity market.  

NPS also cited “concerns over earnings of large tech companies” as a contributing factor in weak local results.  

Last October, South Korean electronics giant and the world’s largest memory chipmaker Samsung issued a public apology for a disappointing third-quarter results. The company was struggling to compete with local rival SK Hynix in the so-called high-bandwidth memory (HBM) area which is a crucial type of chip for AI training; and with Taiwan Semiconductor Manufacturing in contract and custom chipmaking

In other asset classes, global fixed income saw a double-digit return thanks to “robust interest income” and rising US dollar-won exchange rate. Domestic fixed income returned 5 per cent after Bank of Korea delivered two consecutive rate cuts in late 2024. The former represents 7.3 per cent of total assets while the latter represents 28.4 per cent.  

Alternatives constitute 17.1 per cent of the total assets and returned 17.1 per cent to the end of 2024. According to the NPS website, private equity is the biggest component, representing almost half (43.8 per cent) of the alternatives portfolio, followed by real estate (28.2 per cent) and infrastructure (26.2 per cent).  

Dialing back on coal 

This year, NPS will pare back its holdings in coal and divest from companies that derive more than 50 per cent of their revenue from coal-fired powered generation. 

NPS will begin divesting from this year in overseas companies. But a five-year engagement window pushes back any need to divest from domestic companies until 2030, during which time NPS will work with companies to develop energy transition plans and reduce coal sales or capacity ratios to below 50 per cent. 

NPS allocates almost 5 per cent of its global equity portfolio to the energy sector and has an estimated 7 per cent stake in South Korea state-owned utility Korea Electricity Power Company (KEPCO). 

The stricter climate policies have been a long time coming. NPS initially announced plans to phase out coal in May 2021. Further back in its 2020 annual report it detailed plans to “exit from coal finance to reduce carbon emissions”. 

“NPS will stop investing in the construction of new coal power plants at home and abroad and plans to establish phased implementation measures as a preparation stage to apply negative screening,” it said then.  

The fund’s slow progress contrasts with other large investors. For example, Norway’s parliament formally endorsed a move to sell off coal investments from its $1.7 trillion sovereign wealth fund in 2015. 

NPS’s size means it plays a leadership role in South Korea’s local asset management community and the fund’s continued investment in coal has influenced ESG attitudes across the whole market. 

Challenges with engagement 

Engagement is notoriously difficult in South Korea. PensionDanmark recently announced plans to step up pressure on Japan and South Korea to eliminate coal power by 2030. Elsewhere, APG Asset Management divested its holdings of KEPCO after years of struggling to effect change at the utility. 

One reason that engagement is difficult is because of the so-called 5 per cent rule which stops asset owners which collectively own more than 5 per cent of a company’s shares from acting in concert, stalling collective action. Meanwhile South Korean pensions funds are reticent to engage and don’t want to be seen as too active. 

The Korea Sustainability Investing Forum (KoSIF) reacted to NPS’s announcement by urging the Fund Management Committee (NPS’s dedicated fund management arm) to widen the exclusion to companies that get more than 30 per cent of their revenue from coal operations. It also called for NPS to begin calculating financed emissions, set reduction targets, and implement measures to achieve a net-zero asset portfolio by 2040. 

The KoSIF also criticised the “excessively” long engagement period NPS can conduct with South Korean coal companies on their energy transition plans that risk enabling greenwashing.  

The need for riskier assets 

Another initiative that will take place this year is the introduction of a reference portfolio approach. The decision was announced last May as NPS changed its target allocation of risky asset (which does not prescribe the asset class) from 56 to 65 per cent, as the fund aims to yield more investment income.  

The South Korean government previously sounded the alarm on NPS’ future sustainability. The fund is the world’s third-largest pension fund by AUM, behind Japan’s GPIF and Norway’s Government Pension Fund, but despite its mammoth size, official estimates showed the fund will be depleted by 2056 if there is no policy reform. 

South Korea is grappling with the demographic double whammy: a rapidly aging society, and the world’s lowest birth rate. Before President Yoon was impeached in December, he pledged to increase the pension contribution rate from 9 per cent to 13 per cent to be phased in for all age groups by 2040.

The reform plan also includes lifting NPS’ long-term average annual investment return from 4.5 per cent to 5.5 per cent, or higher.  

“In order to increase returns, we will flexibly improve the asset allocation system and smoothly promote investment diversification to stably operate the precious retirement funds of the people,” NPS chief investment officer Seo Won-joo said during the last May’s announcement.  

American exceptionalism, a notion that investors have largely accepted for the past 150-200 years, is under threat, as the US administration moves to make drastic changes on matters including immigration, tariffs, climate change and the deregulation of financial markets.

These proposed changes have the potential to disturb the proven formula for exceptionalism but the new geography of investing, a term coined by Capital Group to describe the approach of evaluating companies based on where they do business rather than where they are domiciled, creates opportunities for asset owners to tap into the US market, at potentially lower valuations, via companies based outside the US.

According to Andy Budden, investment director, Capital Group, there are still attractive opportunities in the US market, with the foundational pillars underpinning the strength of the US economy firmly intact.

“The first foundation is absolutely productivity growth, which is based on this huge domestic market, and the US continuing to be a global hub of innovation,” he said, citing developments in technology and healthcare as examples.

“But it’s not just about productivity growth, which has accounted for two thirds of economic growth since the Second World War, it’s also that the US offers a very attractive proposition for shareholders, underpinned by supportive government policy. It is partly because the financial incentives are very high that [the US] attracts the best talent.”

“Companies are also really good at carefully managing their share count so they don’t dilute shareholders, and the regulators are quite pro-growth, especially compared to regulators in, for example, Europe.”

This formula for exceptionalism has underpinned the strength of US economy for hundreds of years, and remains intact, according to Budden.

However, American exceptionalism comes at a price. US equity market valuations are relatively high compared to most other equity markets, though this has in a large part been driven by certain sectors such as technology, which has been at the center of the sharp rise in market concentration in recent years.

For discerning long-term stock pickers, Budden said the US still represented interesting opportunities but not because of the Trump administration’s strategy to bring opportunities home.

“There’s certainly a case for [investing in] domestically oriented companies but reshoring is something that will take quite a long time so it’s also very important to evaluate companies based on where they do business rather than where they are listed,” he said, citing Capital Group’s concept of the new geography of investing.

Based on Capital Group’s philosophy, where a company is domiciled and receives its mail is increasingly meaningless.

What’s more important in terms of understanding a company and constructing an investment portfolio and assessing risk is understanding how it does business, including where it derives its revenue.

“Most of the best companies are large multi-nationals that do business around the world,” Budden said.

“For a stock picker, that’s a really good opportunity to identify, for example, a great US or Chinese business that’s growing quickly but is listed in Europe and may be potentially benefiting from a lower valuation.”

Despite plenty of discussion, particularly in more recent times, about deglobalisation and countries becoming more insular and self-reliant due to political forces, Budden said the new geography of investing had enduring relevance.

In the US, S&P 500 companies generate 40 per cent of their revenue offshore, according to Capital Group. In Europe, it’s closer to 60 per cent. In Japan, the split is more or less even.

Europe opportunities

For investors looking to capture opportunities in Europe, Budden said investors had cause for optimism, notwithstanding significant challenges in the region.

“Europe is quite disconcerting at the moment for obvious reasons. Geopolitics in the region is a swirl and there are other fairly obvious challenges including a pretty poor track record of productivity growth and a shrinking population,” Budden said.

While these conditions generally don’t bode well for investors, Capital’s view through the lens of the new geography of investing means companies domiciled in Europe could still outperform.

“There are great global businesses inside a ‘European wrapper’ and also remember that countries need to defend themselves so defence spending around the world, including Europe, will increase,” Budden said.

“Europe also needs to fuel itself and it’s likely that it needs to reindustrialise itself as well, so that has the potential to drive an investment super cycle. Europe actually has a really big industrial sector so a lot of these companies could really benefit from these powerful secular trends.”

Asia

As the world’s second largest economy, China is a major global influence, however, China is grappling with a myriad of challenges, particularly a slowdown in economic growth.

Furthermore, China stands to be significantly impacted by the potential for higher tariffs on Chinese imports being touted by the US administration.

For investors, ongoing volatility in the Chinese and Hong Kong markets is expected, Budden said, although it’s not all bad news.

While economic growth is expected to slow amidst headwinds including demographic changes, a housing market downturn and high debt levels, there are attractive opportunities, particularly in technology, and companies that cater to the increasingly sophisticated needs of the Chinese consumer, he said.

“We are absolutely going to see a lot of news flow on geopolitics and tariffs, which is going to take the wind out of the sails of China and Hong Kong, so investors need to be ready for that and stay focused on the long-term,” he said.

Technology, travel and healthcare

Countries and regions aside, Budden cited longer term secular trends and opportunities in a number of sectors, including technology, travel and healthcare.

He likened the rise of AI to the rise of the internet in the early 1990s.

“It is interesting to draw parallels between what we’re experiencing today with AI and what we experienced in the early days of the internet. In those early days, it was all about the on-ramp to the internet and today it’s all about the on-ramp to AI,” Budden said.

“AI requires vast amounts of processing power and we know what that has meant for semi-conductor companies in recent years and, more than likely, going forward.”

“We’re particularly interested in companies that will be first to use AI to improve existing products and services, so really extracting greater productivity from existing products. This is a really important opportunity for investors.”

In other areas, Budden observed a global trend to pursue experiences and not just accumulate more stuff, which has fuelled growth in the travel sector.

“The world is going through a transition. People used to spend most of their money on goods and material possessions but increasingly that money is being spent on experiences and that’s quite an exciting area for investors,” he said.

Published in partnership with Capital Group.

Wellcome Trust is holding nearly 10 per cent of its £37.6 billion portfolio in cash and bonds. The charity focused on health research established in 1936 with legacies from pharmaceutical magnate Sir Henry Wellcome is sitting on the sidelines and waiting for sufficiently interesting long-term investment opportunities to arise – namely a big fall in public equities that would absorb large-scale funds quickly.

The last time Wellcome had a similarly large allocation to cash and bonds was in September 2008 on the eve of the GFC.

“A market fall of sufficient scale would reveal plenty of great companies in public markets that Wellcome Trust would like to own – or own more of,” chief investment officer Nick Moakes tells Top1000funds.com.

“Public market valuations in the all-important US market are stretched and at some point, are likely to normalise either through market falls or an extended period of sideways market movement while earnings catch up.”

Wellcome has been steadily pruning lower conviction holdings since at least 2020 which has contributed to the accumulation of cash in the portfolio. But he notes it is risky holding such a large amount in cash, even though returns are better than in the recent past and the opportunity cost of holding cash is lower.

Wellcome currently receives around 2 per cent real return after inflation on its cash pile, but this is not enough to meet its minimum long-term target return of 4 per cent (after inflation) needed to at least preserve, and preferably grow, the real value of the portfolio. In its latest results the portfolio returned 5.2 per cent  – 3.5 per cent after inflation.

“It does present a risk. We also have to manage counterparty risk carefully,” says Moakes who will retire as CIO at the end of this month, with Lisha Patel and Fabian Thehos stepping up as co-CIOs from April.

Fortunately, some opportunities are starting to appear. Wellcome is deploying significant cash into subdued real estate assets and the team is beginning to see opportunities in private equity too where Wellcome has a 32 per cent allocation to buyout, venture, direct and co investments of which venture is the biggest.

He notes GPs are increasingly open to co-investments and many LPs do not have sufficient liquidity. “Private equity and venture capital valuations are less stretched than they were in 2021 but there is still some excess from that period to be worked through. Essentially too many poor companies were funded and now need to be merged or closed.”

Still, in the shorter term he doesn’t expect the cash flows in Wellcome’s PE portfolio to turn positive until the IPO route to public listings has fully opened and the logjam of VC and PE backed companies waiting to list clears.

An area he won’t be investing is private credit. Like many others Moakes flags looming risks in private credit where he says huge amounts of capital has been sucked as investors attempt to juice returns in their fixed income portfolios.

“Lending standards are very loose with covenant-light loans and compressed spreads. If and when the US economy slows significantly, these vehicles are likely to suffer substantial losses and investors will not be able to find liquidity.” However, he says there is unlikely to be a systemic impact as there was in the GFC because investment has flowed into LPP structures rather than leveraged bank balance sheets.

It leads him to reflect how other investor risks lie in the emergence of large alternative investment managers running many different portfolios.

“Certain large managers of alternatives run private equity, private credit, real estate, and hedge funds and have gone public. They have created a self-contained ecosystem lending to each other’s equity or real estate vehicles. These are great businesses, but their public listing means that interests are not fully aligned with LPs in the underlying funds as public markets value AUM over returns on capital.”

Moakes says another “big issue” in public markets is the momentum trade where passive funds buy the biggest stocks in the market, creating a headwind for active managers of all sorts. The impact has shown up in Wellcome’s actively managed equity portfolio where neither the internally manged portfolio nor Wellcome’s external managers have kept pace with MSCI ACWI since 2020. Although the £16.8 billion public equity and equity long short portfolio returned 13.0 per cent last year that trailed the broader market by a wide margin due to the highly concentrated nature of market returns.

He warns that if markets go into reverse and funds are withdrawn from passive vehicles, there is a risk of a disorderly market move. Although he reflects “in the long-term” passive will continue to dominate the market.

The main winners in the active space have been the platform hedge funds, who are finding alpha and leveraging it up to deliver returns. “The best are very good indeed, but the rise of secondary players means there is a risk that this becomes a crowded space below the top tier of managers.”

He believes bond market volatility is symptomatic of an economy with structural twin deficits – current account and fiscal. However, the fact that it is not just happening in the UK suggests there is something broader going on. “Inflation is still a risk, and it seems more entrenched than central banks would hope, while most governments are having to issue vast quantities of fresh bonds. This is testing the market’s patience.”

Wellcome has no exposure to bonds beyond very short-dated paper held as part of the cash pile.

“There is no direct read across to our portfolio unless equity markets are affected. However, when currency markets are affected, as GBP has been for an extended period, there is an impact on our mark-to-market valuations,” he concludes.

Migros-Pensionskasse (MPK) the CHF29.4 billion ($31 billion) pension fund for Switzerland’s largest retailer, Migros, is in a robust state of health. A coverage ratio of 132.8 per cent means chief investment officer Stephan Bereuter is comfortably taking on more risk via a boosted equity allocation, and last December MPK was able to increase its pay out to beneficiaries.

“We paid an additional 2000 francs to every pensioner. We’ve got letters from people saying how much it meant to them,” he tells Top1000funds.com in an an interview from MPK’s Zurich offices.

Bereuter, who was promoted to CIO in 2022 after a year at the fund which he joined from head of asset management at insurance group Generali, attributes much of the success to internal management (90 per cent of the fund is managed internally) and a dynamic top down/bottom up investment strategy that allows the investment team to buy and sell assets outside the strategic asset allocation in a reactive and flexible approach to opportunities.

Like in May 2023 when MPK invested in insurance-linked securities in an allocation that is not part of MPK’s SAA.

The asset class had struggled since 2017 and by 2022 many investors had thrown in the towel and divested. But it was at this point Bereuter saw the opportunity.

“Spreads had risen and become very high for the risk investors were taking. We were being well compensated and decided to allocate,” he recalls.

Even recent storms in the US haven’t negatively impacted the portfolio which returned 16.5 per cent last year, underscoring the robust attachment point and structure of the investment.

Still, a large part of the return is driven by the long-term strategy, adjusted in an ALM study every four years and an area Bereuter is most focused today. He is increasing the equity allocation via small tweaks to 30 per cent (from 28 per cent) via small tweaks to the portfolio, and boosting the allocation to gold to 3 per cent.

MPK’s equity allocation is below average compared to peers and he believes that in the long run equities will perform well.

“From a strategic point of view, it makes sense to increase equities,” he says.

But the strategy is also indicative of a new caution in US tech stocks that has driven returns for passive investors. Now the boosted allocation will comprise a new, internally managed 3 per cent sleeve that shifts away from US tech stocks to focus instead on companies that have a strong dividend yield and stocks with strong balance sheets and cash flows rather than a pure value approach.

“I don’t think many managers who make active decisions could have outperformed a benchmark portfolio because performance was driven by such few stocks. But we now hope the dividend approach will add diversification, and not be as dominated by tech stocks.”

Gold’s appeal

MPK’s allocation to gold sits with custodian banks and holds compelling fundamental and liquidity benefits.

The precious metal has steadily climbed due to central bank buying, inflation and geopolitical tension and Bereuter also likes the allocation as a hedge against increasingly concerning government debt levels. He argues that even though interest rates are higher, central banks are still in a phase of expansive monetary policy in an ongoing monetary experiment.

“Central Banks have printed so much money in the last decade and Switzerland is a world champion in this regard.”

Given 39 per cent of assets under management are in illiquid allocations to infrastructure and real estate, gold also provides valuable liquidity benefits alongside a cash portfolio and super-high quality issuers. But he says even government bonds have proved illiquid in recent years.

“During Covid government bonds had liquidity issues, but gold didn’t behave the same way. We need gold to provide a bucket of liquidity in stress scenarios.”

Timing real estate

Corners of MPK’s 9 per cent allocation to international real estate are also beginning to show signs of recovery. For example, after three years in the doldrums, he notices core real estate is beginning to re-price to create pockets of value.

“We are in a position to allocate money again,” he says, hoping the team’s experience in actively managing the portfolio will once again pay off.

Successful divestment of the core international allocation to more opportunistic, externally managed strategies in early 2022 on the eve of core being clobbered by lower cap rates and a spike in inflation and interest rates that left many investors struggling to exit was timed perfectly.

“We are now looking at core real estate again. Cap rates have gone up and you can get nice returns moving forward.”

He is still not keen on office but likes data centres and notices opportunities beginning to appear in residential and logistics – although he is also mindful of an economic downturn hitting logistics. “There is over supply in some pockets already.”

Despite the hot money flowing into data centres he believes returns look solid because it is still early in the cycle, although he does favour projects in the near future with clear visibility “It’s not too late to play this investment,” he says.

The internally managed allocation to Swiss real estate accounts for 24 per cent of the total portfolio and he describes the allocation as the “backbone” of the pension’s stable income returns of above 3 per cent.  It is a senior portfolio characterised by long term ownership in strong locations that is now benefiting from rent increases. The portfolio returned 2.5 per cent, 4.80 per cent and 5.7 per cent for its 1-, 3-, and 5-year return, as of September 2024.

At a recent board meeting, trustees at Alaska’s sovereign wealth fund APFC garnered insights on governance from recent turmoil at PSERS’ and Ohio State Teachers.

With the benefit of hindsight, the governance crisis at $73 billion Pennsylvania Public School Employees’ Retirement System (PSERS) that exploded in 2021 to catch everything in its path and result in criminal and regulatory investigations and legal fees running into millions of dollars, was painfully obvious.

Drawing on widely reported stories in the media at the time, Tiffany Reeves, partner, Faegre Drinker Biddle & Reath LLP, laid out PSERS governance issues to gathered trustees at the $82 billion Alaska Permanent Fund Corporation’s (APFC) during a recent board meeting at the Juneau-based fund.

Two-hatted elected officials sat on PSERS board and there was a lack of clarity on the different roles of board and investment staff, she said.

New ideas were blocked by the absence of any succession plan (the board chair had been in situ for 25 years) and the roles and responsibilities of oversight committees was unclear. Trustees regularly fielded multiple designees, creating crowded and unruly board meetings. Staff took lavish trips paid for by money managers leading to conflicts of interest and in another misstep, a material calculation error left beneficiaries having to pay more into their pensions.

Board books – so thick they resembled ‘War and Peace’ – were dropped on the board a few days before meetings, compounding trustee’ fears of looking foolish and unease that the investment team weren’t giving them the information they needed. Dissatisfied factions leaked information to the press and a culture bereft of decorum flourished, characterised by a lack of civility, over-zealous inquiry, interpersonal conflicts, withholding information, defensiveness and politicking.

Reeves said that PSERS’ widely reported governance challenges showed that no matter the value of assets under management, state treasurer, pension fund or sovereign wealth fund, poor governance is caused by recurring and consistent themes.

“When you see these patterns of behaviour, name it and address it swiftly. If you don’t a compounding effect with erode the culture of your organisation. Culture is defined by the worst thing you tolerate,” she said.

In contrast good governance can result in outperformance of 1-3 per cent relative to peers.

Reeves’ presentation marked APFC continuing its efforts to advance and modernise governance practices and align with industry best practices after governance at the fund has come under the spotlight. Last year, leaked emails revealed investment staff had come under pressure to invest in particular strategies from trustee Ellie Rubenstein in a clear conflict of interest. In 2022 “materially below par” compensation linked to budget constraints led to the fund struggling to fill staff vacancies, and in 2021 board members unexpectedly ousted former executive director Angela Rodell.

What is fiduciary duty

Reeves began by addressing the concept of fiduciary duty. Fiduciaries encompass all professionals who make or have the authority to make discretionary administrative or investment decisions related to the fund, encompassing board members to investment managers and investment advisors.

Core fiduciary duties include prudence and loyalty. For example, fiduciaries have a duty to diversify, a duty to provide information; understand trust law, ensure transparency and avoid conflict of interest. Prudence involves a total portfolio perspective rather than focusing on any individual asset class in isolation; the need to consider economic conditions, liquidity and the preservation of the appreciation of capital.

The duty of loyalty means that trustees act only for the beneficiaries. “If the public get annoyed you won’t do something, it’s because they misunderstand what your fiduciary duty is and how you are confined,” she said.

She added that fiduciaries are judged on the prudence of the process behind decision making. Fiduciaries are guided by the material factors that inform decision making at the point in time decisions are made in a defined process – they don’t make decisions and then “reverse engineer” prudence.

Shooting from the hip doesn’t work

Good governance is the bridge between fiduciary duty and the process/implementation – or, as Reeves explained, “the how.”

Governance is rooted in foresight rather than making it up as you go, she said. It supports fiduciaries duty of loyalty and care, and provides guardrails that support decision making, and establishes decision making in advance of challenging situations.

“I can’t stress enough how important it is to establish the rules of the road before a crisis. Shooting from hip doesn’t work.”

Stay in your lane

Good governance also depends on clarity of the different roles of the board and staff. Only this way can board and investment teams stay in their lane.

“It’s hard when you don’t know what your lane is,” she says. Referencing the CFA’s OPERIS governance framework, Reeves said a board role is high level; involved in setting goals and objectives, oversight and monitoring. In contrast, the job of the investment team is to implement and execute.

“The framework is very clear on the powers that are for the board and the powers that are for staff,” she said, adding that the board approves key decisions, sets policy and prudently delegates – although the board is not in a position to delegate oversight.

Trustees should have a line of sight and can drill down when they think it’s appropriate. But they should not go on “a hunting mission” that delves into investment staff decision making. Instead a robust reporting and compliance function should gives trustees comfort and bring access to information and line of sight.

The problem of two hats

Governance gets challenging when fiduciaries wear two hats. For example, fiduciaries might be members of a sponsor organisation, a member of a state employer or political appointees. It’s possible to navigate this conflict by keeping beneficiaries front and centre, she said.

“When you are making decisions, you can only consider beneficiaries.”

There is always tension between what is best for an organisation and what is best for the executive when organisations have state appointees, she continued. A typical area of conflict between state politics and board decisions comes when pension funds seek to recruit internal expertise and pay more than government pay grades. In such cases, trustees must stay mindful of fulfilling their fiduciary duty to grow the trust by hiring qualified individuals.

Fiduciaries have to think what is the best policy for the fund and what will be the long term consequences if the legislature doesn’t support those policies. Reeves reassured that the best decision will arise out of these conflicts. The governance construct will inform the best decision, and she said group decisions are generally better.

Moreover, by filling positions with experts teams can trust they have the governance ability to understand which hat to wear.

She said board members also owe fiduciary duty to each other. They need to actively participate in decision making and maintain effective working relationships and decorum. Board members are liable for the conduct of other trustees and in this way, the board acts as a collective body.

She concluded that in periods of uncertainty, it is more important than ever to have trust because high trust organizations are more resilient.

This article was corrected on 8th March to highlight Tiffany Reeves’ description of the governance challenges at PSERS was wholly drawn from media reports at the time. Reeves has no direct knowledge of the events at PSERS, and this part of the presentation was based on media and public reports.