Understanding our hedging strategy
Background
All members are in the defined benefit (DB) part of USS. This provides them with a guaranteed inflation-linked income for life in retirement, based on salary and years of service.
As Trustee, our role is to ensure the Scheme will have enough money to meet these financial commitments to members now and decades into the future.
Our funding position tracks this by comparing how much money the Scheme has (the value of its assets) with the total estimated cost of paying all the benefits that have been promised to members (the value of its liabilities).
The funding position influences the contributions required of members and employers, which we invest with the aim of generating returns that will help to fund the benefits.
The nature of our liabilities
We are required by law to value our liabilities at least every three years in a way that is consistent with the Scheme’s investment strategy.
At a valuation, we calculate:
- the present value of our liabilities by discounting them at rates we prudently expect to generate from our investments in future (the present value of our liabilities is the upfront cost of all the benefits that have been promised to members to date)
- the estimated cost of funding new benefits in the future
This helps us to work out the level of assets we need to fund members’ accrued benefits and any contributions needed to fund future accrual.
UK interest rates (specifically, the returns offered by government and corporate bonds) and inflation impact expected investment returns and, therefore, the present value of our liabilities.
Members’ defined benefits, once earned, are also increased annually broadly in line with CPI inflation (subject to certain caps when inflation is above 5%).
So, all other things being equal, if interest rates fall or inflation rises, the value of our liabilities increase.
We invest in return-seeking growth assets, such as equities, with the aim of generating returns that can help to reduce the expected cost of providing benefits.
However, the value of these types of assets can fluctuate in a way different from the Scheme’s liabilities. This can drive volatility in the funding position.
The amount we invest in growth assets is therefore constrained by the funding position at the time and how much volatility our sponsoring employers are willing and able to support — both of which inform how much risk the Trustee is willing to take (our risk appetite).
Prioritising the funding position
If a valuation shows that our assets are worth more than our liabilities, we have a funding surplus. But if our assets are worth less than our liabilities, we have a funding deficit — and the Pensions Regulator expects a deficit to be recovered as soon as employers can reasonably afford.
In some previous periods, the divergence between the value of our assets and liabilities was significant. Between 2008 and 2020 the value of our assets more than doubled (from £29bn in 2008 to £66.5bn in 2020), but interest rates caused the value of our liabilities to grow at an even faster rate — and the Scheme developed a persistent and significant deficit.
This resulted in deficit recovery contributions being required in addition to rising normal contributions, which was very painful for both members and employers. Over this period, there were also cuts to the pension benefits offered to members in response to the rising contribution costs.
We want to avoid this happening again where we reasonably can. Even though stakeholders are clear that they want the Scheme to remain open, regulations require us to fund the Scheme in a way that is compatible with us taking less risk as the Scheme matures. However, as an open Scheme, the point of maturity is in the distant future.
All of this means investing in a way that generates investment returns but which also keeps a close eye on the funding position and how it might change in the future.
Our objective is, therefore, not to target absolute returns above all else. Rather, we aim to outperform the Scheme’s liabilities over time.
And our liability hedging strategy plays a significant part in helping us to achieve that.
What is hedging?
Hedging involves investing in assets like government bonds that offer returns that are linked to UK interest rates, inflation, or both.
The values of these assets are expected to move in a similar way to the value of the liabilities. Indeed, as well as hedging assets we refer to them elsewhere as liability matching assets. (Some of our private markets investments are growth assets that may also provide some long-term liability matching elements to their returns.)
The more we hedge against adverse movements in inflation and interest rates, the more we protect the funding position from market volatility. This, in turn, supports greater stability in terms of both contribution rates and benefits.
Currently, we hedge about 50% of the Scheme’s inflation and interest rate risks*. So, if the value of our liabilities increases because interest rates fall, our hedging assets are expected to offset around half of that change.
The returns offered by hedging assets are typically lower than the returns we would expect to achieve, over the long-term, from investing in return-seeking assets such as equities and corporate bonds. But this misses a fundamental point: that is not, primarily, why we invest in hedging assets.
Their strategic contribution is how effectively they help us to manage key funding risks and ensure the Scheme can meet its liabilities in a range of economic environments.
That is why we do not report a standalone return on our hedging assets.
In fact, as we are not fully hedged, a lower or negative return on our hedges might represent an overall positive result where it was driven by rising interest rates or falling inflation expectations; conditions that would, all else equal, reduce the present value of our liabilities and so improve the funding position.
Supporting growth
We still want to generate investment returns that can help to reduce the contributions we would otherwise need from members and employers rather than if we just invested in assets such as bonds.
That is why the majority of the Scheme’s DB portfolio is invested in growth assets.
But hedging can also play an important role here too; one that is sometimes lost or overlooked: the more we hedge inflation and interest rate risk, the more capacity we have to invest in growth assets (up to a limit, driven by how much leverage we can take).
As set out above, there is a limit to how far the Trustee can allow the funding position to worsen before taking action, given the legal and regulatory environment in which we operate, including the Trustee’s fiduciary responsibilities.
If we had run a significantly lower hedge ratio from 2017 to 2023, when the funding position was under considerable strain, we would have needed to have less in growth assets in order to remain within risk appetite, which would in turn have diminished returns.
In fact, we estimate the gains from having more in growth assets over this period, made possible by having greater hedges, to be more than twice the losses that could be attributable to the hedges. This is explained in more detail in our briefing paper Hedging and returns.
Outcomes
Between March 2020 and March 2026, the funding position improved by about £30bn, from a deficit of about £14bn to a surplus of almost £17bn.
The current member contribution rate of 6.1%, introduced following the 2023 valuation, is the lowest in the Scheme’s history; the current employer contribution rate of 14.5% is the lowest since 2009.
We believe that, whilst aided by helpful market conditions, the choices made in this period have contributed significantly to these outcomes and, perhaps more importantly, have put the funding position on a more resilient footing for the future, as explained in greater detail in the briefing paper.
How are our hedge ratios set?
The Trustee sets a Valuation Investment Strategy (VIS), which reflects the Trustee Board’s long‑term risk appetite and is agreed as part of each actuarial valuation. One aspect of the VIS is the hedge ratios for interest rates and for inflation.
The Trustee delegates implementation of the VIS to USS Investment Management (USSIM).
USSIM’s actual investment portfolio takes account of the Trustee’s high‑level hedge ratio targets.
This includes determining:
- The overall interest rate and inflation hedge ratio to have in the portfolio, given market conditions
- The balance between GBP and non‑GBP hedging (e.g., USD, EUR), taking into account the Scheme’s wider asset mix and risk exposures**
- How much hedging already comes from other assets
Hedge ratios vary from day to day as markets move but are managed to remain within ranges set by the Trustee Board’s Investment Committee.
*Relative to the Scheme’s low-risk self-sufficiency funding measure.
**Although the Scheme’s liabilities are denominated in sterling, we use assets in other major markets such as the US or Europe to help deliver the hedge efficiently and cost‑effectively. This diversifies the sources of protection — which was particularly beneficial during the gilts crisis in late 2022, can reduce costs and allow for operational flexibility and liquidity management, while still ensuring the overall hedge remains aligned to UK‑specific risks.
Document downloads
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USS briefing Hedging and Returns July 2026 pdf (366kb)