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Portfolio Construction and Risk Management

Find out more about how we construct the portfolio to meet the trustee’s investment objectives

The methods we use

We use a number of different tools in order to determine the optimal asset mix for USS in respect of the amount of risk that has been set by the trustee. At a basic level, we use fundamental building blocks - breaking down the expected returns for each asset class into components.

These building blocks vary for each asset class, but generally include yield (e.g. coupons for bonds or dividends for equity), growth, the initial valuation level (versus our assessment of what that valuation should be in the longer term), foreign exchange and other fundamental factors (e.g. expected default losses in credit portfolios). Doing this helps us forecast returns for each asset class based on underlying fundamental drivers and long-run macro projections.

We also consider environmental, social and governance (ESG) factors, and the impact of the asset mix on USS’s ambition to achieve net zero by 2050.

In looking more deeply at risk, we budget the risk exposures across each asset class to ensure that the risks being taken by USS are deliberate, diversified and appropriately scaled. That means not just looking at risk today but also how that these may change over time depending on what assets we invest in.

We consider the Valuation Investment Strategy (VIS) – a high-level investment strategy for the defined benefit (DB) section of the scheme that was developed for the most recent actuarial valuation. It is adjusted from time to time to retain consistency with the Integrated Risk Management Framework (IRMF) and the trustee’s risk appetite. Read the composition of the VIS as at the most recent valuation.

We estimate the future risks, returns and correlations between asset classes. This helps assess the best combination of asset classes for a given risk level or return requirement (this is known as an “efficient frontier”), taking into account specific regulatory, liquidity or implementation constraints.

We also use an economic scenario generator to simulate potential future outcomes (stochastic modelling). This helps us to make probability-based decisions – for example, on the likelihood of interest rates rising or falling in the future. And overlaid onto that we also look at different macro-economic scenarios which helps us further build a picture of what the potential outcomes might be. This could be in absolute terms for DC or relative to liabilities in DB.

While these are some of the key tools that we use to construct the portfolio, as a long-term responsible investor there are other considerations we must keep in mind. For example, we are an active manager – USSIM invests the majority of the assets of USS in-house, using external managers only where it makes financial sense to do so. In 2020, USSIM was able to deliver its investment programme at nearly £50m less than comparable peers according to independent benchmarking done for the 2020 Report and Accounts.

Also, we are a responsible investor. We believe that good corporate governance means better run, more sustainable companies and therefore better long-term investment performance. Read more about our responsible investment philosophy.

Another key driver of our investment planning is around liability hedging. We hedge some of the interest-rate and inflation sensitivities of USS's liabilities in the defined benefit section to reduce asset-liability risk. As a pension scheme with long-term liabilities – the need to pay pension promises as they fall due – we actively look for opportunities to invest for the long-term but with more certainty in terms of returns. We also hedge against currency risk to reduce the volatility of our non-UK investments.