UK -  The UK's second-largest pension fund, the Universities Superannuation Scheme (USS), has reported its funding level has fallen from 98% to around 77%, the same level it was three years ago.

Figures from the pension fund annual report for the year ending 31 March 2008 show the value of the scheme fell £1.26bn (€1.62bn) over the year from £30.36bn to £29.098bn, although an overall return of 7.5% for 2007 meant the fund had increased in value to over £32bn at the end of December.

The report showed the biggest fall in the value of the schemes investments occurred in the first quarter of 2008 as "adverse market movements" reduced the fund value to £29.1bn by 31 March 2008 from a high of £32.6bn at 31 December 2007.

The last triennial valuation of the fund in 2005 revealed the USS, which has 252,700 members, was 77% funded although the actuarial estimate for March 2007 suggested this had increased to 91%.

The report said market volatility in the last year has meant the estimated funding level initially increased to around 98% in June 2007 but by the end of March 2008 it had "fallen back to roughly the same level that it had been at 31 March 2005", which was 77%.

The pension fund blamed the fluctuation in the scheme's funding level on a "combination of the volatility of the investment returns on the scheme's assets compared to the returns allowed for in the funding assumptions and also the changing gilt yields, which are used to place a value on the scheme's liabilities".

That said, it claimed on an FRS17 accounting basis, using an estimated AA bond discount rate of 6%, the estimated funding level at 31 March 2008 was 104%, while an estimate of the funding level on a buy-out basis was approximately 78%.

The next valuation was scheduled for March 2008 so the USS confirmed it had not included a more detailed funding statement for the scheme in its annual report and instead said, "an updated statement will be published in January 2009 following the completion of the actuarial valuation".

Figures from the report revealed that over the year to 31 December 2007 the overall return of the fund was 7.5%, 1.2 percentage points ahead of the benchmark, with the majority of the outperformance resulting from an overweight position in Pacific equities and underweight allocation to property.

It also showed "mixed results" from individual managers against their benchmarks, with the scheme's in-house investment team at the London Investment Office (LIO) - which manages the majority of the assets - posting the best performance with a return of 7.7% against a target of 5.3%

In contrast, the two external managers for specialist global equity mandates, Capital International and Wellington International, both underperformed in 2007 by 3.2 percentage points and 1.8 percentage points respectively.

The poor performances were mainly attributed to "poor sector and stock selection", but while Capital International outperformed the benchmark by 0.3 percentage points per year over the period of its mandate, Wellington International has continually underperformed by about 1.5 percentage points per year.

As a result, USS confirmed "due to continuing disappointing performance, the mandate with Wellington was terminated at the end of November 2007 and the assets put under the management of the LIO".

The current asset allocation of the fund is 35% in UK equities, 42% in overseas equities, 9% in fixed interest, 6% in property, 3% in cash and other and 4% in alternative investments.

However, the report stated the fund is continuing to diversify into alternative assets, with the aim of "increasing this to 20% over the medium term", to include private equity, absolute return and commodities.

That said, the fund admitted the move towards alternatives will result in an increase in annual investment costs and the need for strong governance, so it warned it intends to achieve this through "the growth of our in-house investment management expertise and focusing strongly on holding our external managers and suppliers to account for any cost spiral".

Following the publication of the annual report, USS also issued an update regarding the continued market volatility since the end of March 2008, in which it reassured members that its portfolio "is designed to withstand volatile market movements".

The USS also revealed the LIO had "been concerned about the excessive levels of debt in relation to assets in the financial system for some time and as a result already last year moved to reduce its exposure to the financial sector".

It added the fund had attempted in recent years to increase its allocation to assets offering similar returns to equities but without the link to equity markets, which has driven its exposure to alternatives assets.

However, it highlighted within its alternatives portfolio "the fund has adopted a cautious approach to hedge funds and has minimal exposure to either individual hedge funds or fund of hedge fund companies".

In conclusion, the USS said: "We will continue to monitor closely movements in markets and in line with the long-term investment strategy of the fund will look to take advantage of attractive investment opportunities generated by this extreme market volatility."

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