The conversation we’re not having about investments

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The recent Paradise Papers revelations, featuring the HE sector’s main pension fund (USS), as well as the endowment funds of the Universities of Oxford and Cambridge, and 29 of their 69 colleges, have once more put university investments in the headlines. According to the Guardian, in 2006 these institutions all invested in a fund run by a private equity firm based in Guernsey, and in other offshore funds at later dates. The Guernsey fund’s biggest investment was the fossil-fuel company Shell.

While there may be some in universities that wish this hadn’t become front page news, it’s important that, rather than brush it under the carpet, the sector takes advantage of the exposure to have the important conversation that it has been skirting around for a while. For a while the amounts involved were just a tiny fraction of those institutions’ relative investment pots, the underlying issues deserve a longer examination.

While I’m not a fan of the fact that the funds were based ‘offshore’, and could potentially have avoided taxes in some territories (the US in this case), that’s not the big story here. The Paradise Papers point us to a more complex story about where endowment and pension funds put their money, and why.

And it’s a story in which many of us are complicit.

Universities (and, for the sake of brevity, I include the university-owned USS pension fund here) must put their money somewhere. Unlike the short-term management of operational cash-flow or the medium-term juggling of savings and borrowings for strategic purposes, the investment of endowments and pension funds is a distinctly long-term business.

The money is invested on a rolling basis, over the very long-term of tens or even hundreds of years. It’s added to and drawn from (such as when scholarships are created in the case of endowments, or workers retire in the case of pensions), but it is never spent completely. The cash is invested in all sorts of things; countries, companies, private credit (including the infamous ‘Asset-Backed Security’), aggregated funds, land, property, and much more.

Long-term needs

The long-term investments of universities and their pension funds have specific requirements. First, they need to go somewhere that matches their long-term nature. This could mean investments in government bonds (although these are typically very low-return at the moment), or big companies that have been around for a while and have a consistent track record, or in land or property.

Second, investments need to produce a good return. For endowments and pensions to offer long-term benefits to pensioners and the ‘future university’, it needs to compare favourably with inflation, and hopefully do so every year. So universities aren’t looking to make a quick buck.

They’re again looking for services and industries that are established and high-performing for long periods.

Third, investments need to be very low risk. If you’re only investing for a year or two, you might be able to get away with a slightly higher-risk strategy, but if you still want the pot to be around in 50 years’ time when that new employee starts drawing their pension, and in perpetuity after that, then you can’t afford to take chances. You can’t gamble on new or speculative industries. What’s wrong with a university deciding to invest in something that is say, just 2 percent riskier? Well, there are over 100 good-sized universities in the UK.

Logic dictates that we could see two big news stories hit the headlines about a UK university that had to lay-off staff, or abandon courses, or halt future plans due to the mismanagement of investment funds.

Finally, universities need to have expert staff to manage those investments, with robust governance in place, and to provide the service in an efficient manner. University investment teams are competing against very deep-pocketed industries for the best talent and must do so while ensuring the cost of managing their investments doesn’t become so high that it becomes pointless investing in the first place. It means keeping fees to a minimum, and reinforces a trend away from wheeler-dealing, and towards placing larger investments for longer periods of time with fewer companies or funds.

Balancing the choices

Universities manage and balance all these, often competing, requirements. They can’t have a committee providing individual oversight of every decision to move money, but neither can they just let fund managers invest wherever and whenever they want as if they were trading in the City, with all the risk that entails. So, they typically have a finance committee that establishes a framework for where and how the university should invest its money, along with rules and metrics on levels of risk and types of investments, to ensure the framework is being adhered to.

To meet all the investment requirements above, the framework has to be tightly drawn, and the targets for investment are thus a short list. They typically allow just a few of the largest (and therefore safest) banks, the largest (typically FTSE 100) companies, and large aggregate investment funds, where risks are shared with other large investors but where, as a result, universities don’t always have a huge say in what is invested in.

What exacerbates the issues with this narrow pool, is that to keep risk low universities (and any other big investor), will spread their investments across industries. You don’t put all your eggs in one basket, so you don’t just invest in large banks (in case there’s a financial crash, as in 2008), or just tech companies (in case there’s a crash in tech stocks, as in 2001). This further limits the options available.

So what’s the problem?

Why not just invest in the ‘ethical’ companies out of that narrow band of options above? Well, the problem is that everyone is at it.

There are a handful of large banks, that includes historical supporters of the sector, which have branches or subsidiaries in various countries, that haven’t covered themselves with glory in recent years. From miss-selling to money laundering and then there’s casual incompetence.

The ratings agencies couldn’t spot widespread vulnerabilities in these banks or the coming global financial crisis, despite that being their one job. The intermediaries involved are typically financial advisers that, while perhaps made up of well-meaning people (who frequently move between roles in that sector and other sectors, including HE), are occasionally fined for negligence or misconduct, and arguably play a key role in facilitating the whole offshore system.

The biggest non-bank companies aren’t much better. Have a look down the list of FTSE 100 companies and, even after you’ve filtered out the tobacco, alcohol, oil and gas firms, the betting companies, big sugar, the strip miners, the arms companies, and the other less desirables, you’re still left with a list that looks less than holy.

And what do those remaining companies invest their endowments or pensions in? Even if they are not ‘dodgy’ themselves, do they share your investment values? In 2011, 98% of FTSE 100 companies were found to have subsidiary companies in jurisdictions classed as tax havens. The two that didn’t? A mining company and an investment management company that would help you invest in all the others. I’d hazard a guess that 100% of UK universities (and local authorities, and NHS trusts, and government departments…) invest in, receive research funding from, or award significant business to, organisations that either operate directly in tax havens, or do so via their subsidiaries.

Whether we like it or not, if we work at a university, either as a student or a member of staff, we benefit from this investment. Steady, low-risk, long-term returns from big, established funds and companies allow universities to make the most of their money, provide top quality campuses and facilities, award scholarships and bursaries to students year after year, fund high-quality research and, of course, offer excellent pensions and benefits to staff.

What should universities do about the whole furore? They should start by being frank and transparent about what they invest in, and why, and the compromises they must make. They shouldn’t hide away, but rather welcome the chance to talk to, listen to, and educate students, staff, and unions on the challenges that they face – the challenge of where to put their money.

Some universities already embrace such an approach.

There are compromises to make. If we want truly ethical endowments and pension funds, that are also low-risk, then we must accept lower returns, and so either lower rewards or a raise in pension contributions. If we want ethical funds which are also high-return, then we accept higher risk, and with it the lottery that the odd scheme or fund collapses as a result, with serious consequences.

University investment managers are not bad people. They are trying to do the best they can faced with imperfect choices. There may be some better, more creative options out there, and the unique nature of universities as creators and appliers of knowledge means they should be at the forefront of uncovering those possibilities and sharing them widely.

The sector, if not society as a whole, needs to do that together, without simply pointing the finger, and be open and honest about the challenges, and even the compromises, that might result.

Matt writes here in a personal capacity.

2 thoughts on “The conversation we’re not having about investments”

  1. “If you’re only investing for a year or two, you might be able to get away with a slightly higher-risk strategy, but if you still want the pot to be around in 50 years’ time when that new employee starts drawing their pension, and in perpetuity after that, then you can’t afford to take chances.” This is completely wrong. It’s the other way around! Over the short term, you invest at lower risk as you know you’re going to draw down soon, so have less margin for a market downturn. Over the longer time period, your appetite for risk (and consequent volatility) ought to be much higher; the inevitable drawdowns in the next 50 years are much less likely to affect your 50 year return. Unless the drawdown happens in the last few years; which is why common practise is to shift to less risky investments, as your time horizon nears.

    Your point about needing to focus on low fees is absolutely spot-on. Most people miss that; the difference between sub 1% and anything higher compounds to enormous sums over surprisingly short periods of time. Even personal investors must pay attention to fees.

    It also must be mentioned that most people own funds registered in tax havens in their personal pensions and likely even ISAs, without knowing about it. The Paradise Papers, as far as I can tell, exposed absolutely nothing that isn’t already common knowledge, not to mention common practise for millions of normal folks like us.

    (personal comments)

  2. Matt Sisson says:

    Thanks for the correction James. Each investment will have it’s own risk requirements, beyond the simplification of whether it is just short or long term. The point I wanted to make was that pension funds need to have a lower risk profile, and that substantially limits the options.

    You are entirely correct about personal pensions and ISAs. I would extend this to the choices we all make about which companies we buy our car fuel, or own gas and electricity from, or where we do our weekly shop, or where we buy our clothes. We do so primarily based on price (‘return’) and quality (‘risk’), and yet we expect different standards from our institutions…

    Then there’s the whole issue of pension funds contributing to asset bubbles, whether stocks or property, rather than investing in the real economy – but alas, I was already pushing the word count…

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