16bn reasons why USS was saved by the discount rate

Richard Disney’s verdict on the state of the USS pension scheme , which as I mentioned last week, is showing that it lost £16bn of its asset base in the twelve months to 2023.

Bearing in mind the USS is an open DB scheme with no  need to hedge its liabilities this takes some doing.

The 131 pages of the USS’ report and accounts will be studied by my colleagues to discover whether a fair value is attributed to the less easy value holdings, in particular the 20% stake in Thames Water held by the trust. My inspection – confirmed by Con Keating – suggests that the document doesn’t give Thames Water a mention.

The central message we are asked to accept is that the scheme is now in surplus and this is because the notional value of the liabilities has fallen even faster than the assets.

The most telling chart in the long document is a simple one. A comparison of the return achieved by the fund for DC members (0.9%) and the return on the DB assets (18%).

The lower chart represents the performance of the DC section (growth phase) and the upper chart the performance of the DB section. You will note that it is not just in 2022 that the DC performance exceeds that of the DB fund.

Why are DB assets performing so much worse than DC assets?

My guess is that the 41.1% allocation to liability matching (LDI) assets gives us the answer. The scheme has and is still borrowing money to buy unproductive gilts as a hedge against interest rates and inflation rising. That borrowing is stated as 27.6% , which has cost USS a lot of money in a bear market for gilts.

By contrast, the USS DC scheme has done remarkably well, just when the DB scheme has done remarkably badly. The accounts tell us

..when our DC investment advisor reviewed the USS Growth fund which comprises the growth phase of the USS Default Lifestyle Option against 16 UK DC master trust default
growth fund returns, USSIM’s diversified portfolios performed better than almost all those peer DC funds. This outperformance
over the year was driven, primarily, by the strategy’s allocation to private market assets

The DC fund is drawing on the DB funds investment management agreements, accessing asset management at massively discounted rates and finding assets open only to huge funds of the size of the DB fund. The private market assets are a major case in point. While the DB fund lists its asset allocation (see above) there is no such listing of the DC fund’s asset allocation (there should be – it would be helpful to know what good looked like).

Assuming these private market assets are being properly valued then this is not just a good news story for USS DC members but it’s good news story for a Government needing evidence that a 5% allocation to private equity can lead to a 10% uplift in pensions (Jeremy Hunt and GAD). USS claim to have cut investment management costs by £137m this year by taking much of the management in house. This too should be noted by those who don’t believe that scale can bring value.

But , and this is the point of this blog, if the DB fund is being run as an open scheme, why is not adopting an investment strategy closer to the growth phase of its DC scheme. Why is there a 41% allocation to LDI , why is the fund still involving itself in borrowing money (leverage) to hold assets which it doesn’t need?

If the USS was heading for buy-out or self-sufficiency and if it was still looking to close for future accrual, having this LDI portfolio would make sense. But right now it looks like a £10bn – £16bn  mistake.

Let’s not beat around the bush. The total allocation to Private Equity that the Government is looking to raise is £75bn. In March 2022, USS’ Retirement Income Builder was valued at nearly £90bn and a year later it was valued at just over £73bn. It lost in a year over a fifth of the Mansion House’s ambitions from pensions for productive finance!

This kind of mis-management doesn’t come cheap. To lose money on such an epic scale you need to pay money to your staff – on an epic scale

One employee (not the CEO) appears to have been paid over £2.25m.

Saved by the discount rate?

There are far too many fingers in the USS pie, for the £15.9bn loss to be called by the pension industry. If that £90bn had been invested in the DC growth fund , the loss would have been  (o.9%) or around £800m – still a lot of money but it would have meant the reported surplus would be £15bn higher, money that could have been used to lower contribution rates , enabling Universities to invest more in staff , physical resources and offer lower costs to students by way of tuition and accomodation.

The blushes of the USS management have been saved by the discount rate, but that they are crowing throughout this 133 page report about the achievement of returning to surplus, ignores the opportunity cost of not running this scheme for growth.

There is a good story to be told, were the scheme to be run with conviction. But that conviction is not there, a 41% allocation to leveraged LDI tells us that.

In truth, these accounts show a terrible picture of unnecessary losses, we can only hope that the losses that the private market investments have inevitably taken , are fully accounted for , and that there isn’t more bad news to come.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to 16bn reasons why USS was saved by the discount rate

  1. Con Keating says:

    Thames Water does not merit a mention in this report, which is interesting in itself.
    The valuation of private investments in this report is highly questionable. The scheme also reports leverage of 127%, an important multiplier of losses in bear markets.

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