Fixed Income or “Bonds” are held in the USS portfolio for three primary reasons;
- source of income
- protection against economic and equity weakness
- stabilising asset vs our liabilities.
1. As a source of income
The majority of Bonds pay a fixed coupon (interest). This provides us with a predictable income over a known period of time and is useful in meeting predictable pension payments.
2. For protection against economic and equity weakness:
Our bond portfolio is targeted to perform during periods of economic and equity markets distress.
It is typically concentrated in Government fixed income issues from around the world, which provides us with a high level of confidence in the timely payment of both coupons and principal.
Our portfolio is typically concentrated in bonds maturing in 10 years or more, providing us with assets that are highly sensitive to changes in interest rates. At times of economic and equity markets distress we anticipate the bond portfolio will rise in value.
3. As stabilising asset vs our liabilities:
The performance of the bond portfolio is assumed to be positively correlated to changes in the actuarial value of our liabilities due to changes in the discount rate.
Our allocation to bonds reduces changes in our solvency measures.
Our portfolio is focussed in Government bond markets in developed countries (mainly Europe, Japan, US and UK). These markets are accessed directly by our Fixed Income team at our London Investment Office.
Our portfolio moves assets between Government bond markets based on a number of factors focussing on markets providing: the highest currency hedged yield in pound sterling;
these become anomalously cheap to their peers; in bonds with a high sensitivity to changes in interest rates when we believe interest rates are set to fall and those with a low sensitivity to changes in interest rates when we believe interest rates are set to rise.
Additionally, our portfolio invests in Emerging Government bond markets and/or Corporate bond markets when we believe they offer an exceptionally attractive risk premium.
How does USS implement its currency strategy?
Currency is viewed as an unwanted by-product of diversifying our assets globally.
Our strategy for foreign currency exposure is to cancel out the exposure inherent in our global portfolios with a programme of currency hedging. This program results in retaining the benefits of globally diversified portfolios of assets, whilst removing volatility from changes in foreign currencies.
Presently, the currency hedging program provides the whole portfolio with a small additional return as currency risk is removed.
Currency exposure is reintroduced selectively where we believe foreign currencies may appreciate against pound sterling.