ESG progress for large funds: USS

The £23 billion ($37.7 billion) Universities Superannuation Scheme is the UK’s second largest pension fund and a signatory to the UN’s Principles for Responsible Investment. Kristen Paech talks to the fund’s co-head of responsible investment, David Russell, about the role institutional investors are playing in effecting environmental, social and governance change.

Earlier this year, members of the Private Equity Council (PEC) in the US adopted a set of responsible investment guidelines to be applied prior to investing in companies and during the period of their ownership.

The guidelines were a product of dialogue between PEC members and a group of the world’s major institutional investors, including the Universities Superannuation Scheme (USS), which took place under the umbrella of the United Nations-backed Principles for Responsible Investment (PRI).

They cover environmental, health, safety, labour, governance and social issues, and are evidence of the way in which institutions globally are using their muscle to effect ESG change.

USS first adopted a responsible investment (RI) policy in 1999, using a three-pronged approach of integration, engagement and broad market lobbying to effect change.

The fund has a team of five dedicated to implementing the RI policy, co-headed by David Russell and Daniel Summerfield.

“The area I’ve personally been most involved with recently is the private equity sector, where 18 months ago there was very little effort put into addressing responsible investment,” says David Russell, co-head of responsible investment at USS.

“But over that period, PRI has helped lead the process where we’ve seen the major players in the US, the Private Equity Council members, who are the largest buy-out firms in the world, sign up to a set of their own guidelines and the PRI is driving responsible investment within the private equity sector.”

The Council has agreed to meet with PRI twice annually to discuss the guidelines, and ESG issues generally.

When USS first began implementing its RI policy, Russell says the emphasis was on engagement with the companies in which the fund invests.

More recently though, the focus has shifted from engagement to integration, where ESG issues are incorporated into the fund’s investment decision-making processes.

“We now put a lot more resource into the integration side than we did in the past, mainly because the market has made these issues more material,” he says.

“The most obvious driver for this has been the cost of carbon in Europe where you can now put a number on a climate change-related policy and say this will positively or negatively impact the value of a company.”

USS has already begun to analyse its Australian investments with the cost of carbon built in, as Australia prepares to implement an emissions trading scheme.

A unique advantage of the fund compared to many other UK pension funds when it comes to integrating ESG into investment decision-making is that 90 per cent of the fund’s assets are managed internally.

According to Russell, the most successful engagements include representation from both the responsible investment team, and the portfolio managers themselves.

“It sends a much stronger signal to the company that these issues are material, as we’ve got the fund managers involved who will use the information they get from the engagement in their investment decisions,” he says.

“So it’s a cross over between engagement and integration. Those engagements are very resource intensive so we don’t do a huge number of them but they are very successful in terms of hopefully not only generating change within the company but also providing better information for betterinvestment decisions.”

USS has recently been actively engaged in Taiwan at both a market wide and a stock-specific level.

During the summer of 2008, the fund participated in a conference to encourage Taiwanese companies to more actively consider corporate social responsibility (CSR) issues, and also met with regulators to encourage better governance and CSR reporting by Taiwanese companies.

The engagement was successful; Taiwan has in the last year introduced CSR reporting requirements.

USS also took an active role in engaging with a large Taiwanese bank. One of the pension fund’s fund managers and members of the responsible investment team met and participated in teleconferences with market regulators, the Taiwanese government (which is a major shareholder in the bank), the company, and other investors to iron out serious governance concerns that USS had regarding a potential takeover.

A new challenge facing USS this year comes in the fund’s imminent move into the hedge fund arena.

The fund recently began building up its in-house hedge fund capability in anticipation of a move into hedge funds, which will expand on the $200 million replication mandate awarded to State Street Global Advisors last year.

Russell admits the fund is yet to work out how the RI focus will be adapted to the hedge fund space.

“That’s a work in progress,” he says. “We have not as yet made any hedge fund investments. We’re looking at how we can apply responsible investment to hedge funds from within a mainstream portfolio perspective. That will include issues around transparency and governance of funds; we’ll also look at how hedge funds vote their stocks, because that can have implications for us as equity holders in other contexts.”

He adds: “Most people think of hedge funds as a long-short type fund where there are plenty of similarities with equity teams, because you’re buying stocks based on detailed analysis of those stocks or shorting stocks. Part of the focus will be on how extra-financial information is used within the investment decision-making process just as you would have within a long-only equity fund.”