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The £23 billion ($46.7
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 – and the
challenge of applying them to burgeoning hedge fund portfolios. 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 better investment 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


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. 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 US$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’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.”


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