On one of the walls at the offices of Chris Hitchen, the chief executive of Railpen, the £19bn (€25bn, $38bn) UK railways pension scheme, is a clock which ticks backwards. “A colleague bought it for me because she says I take on too much, and this way, I’ll have enough time in the day to do what needs to be done,” he explains.
But time is an issue here. His day job is massive: managing Railpen, which encompasses nine member schemes including the British Railways Superannuation Fund, the British Transport Police Force Superannuation Fund and five small funds linked to former railways. “It’s a very complex scheme and essentially 100 schemes stuck together, we pool assets to achieve economies of scale and to be able to have a good investment strategy,” he says. Of the Railpen schemes, the 340,000 member Railways Pension Scheme, a mix of defined benefit and defined contribution and created in the aftermath of industry privatisation, is the largest holding more than 90 per cent of investable assets.
In his “spare time” he also acts as chairman of the National Association of Pension Funds (NAPF). “I run the NAPF board, oversee the chief executive, and meet with government ministers, however if Railpen’s trustees ask me how much time it takes, I reply - very, very little,” he says.
Unlike the novelty clock which ticks in the background during FT Mandate’s interview with Mr Hitchen, it becomes clear very quickly that Railpen’s investment strategy and outlook is anything but backward looking. And here, as influential as an ageing scheme
membership, a volatile UK equities market, or accounting standards for pensions is, in terms of where assets should be allocated and how, what Calpers has done in the past two decades in alternatives exposure, corporate governance and internal investment management are of equal import. “We’ve learned much from our peers, from US pension funds, sovereign wealth funds, and endowment funds over the years,” he says.
Indeed, before sovereign wealth funds became something of a bête noire, their investment strategies and innovation were often revered by institutions. “You can’t bracket SWFs,” notes the Railpen chief. “In many ways, they are beacons of good practice in investment management but now the view is they’re throwing their weight around. I’ve met a number of these funds and learned a lot.”
Alternatives
Railpen raised the bar for UK pensions allocating to alternatives when in 2005 it announced an initial five per cent shift to hedge funds (rising to 8 per cent) through a £850m Cash Plus Pooled Fund benchmarked to 3 month Libor.
“You could invest entirely in low yielding, long-dated bonds and just make members and employers pay much higher contributions, however we have to balance things out,” he explains. “We can’t avoid looking at areas that might produce interesting returns, as there is a risk in not looking at this space as much as there is in investing in alternative assets,” he adds.
Railpen targets a return of 4 per cent above Libor for its pooled funds and 2.5 per cent over Libor for its hedge funds, which constitute multi-strategies in around 80 underlying hedge funds. “We try and spread risk as much as we can,” he adds.
Mr Hitchen sets out his vision of the future, with alternatives (hedge funds, property, infrastructure and private equity) now playing a major role for new entrants to the scheme (and the reverse applies for more mature sections). The new entrants part of the scheme is currently running at 10 per cent in hedge funds of funds, 10 per cent property, 10 per cent private (unquoted) equity, 10 per cent in infrastructure, the remainder in global bonds and quoted equities (half of total assets). “This is the template for many sections of the scheme, though we are still working on weightings. The idea is to build up diversified strategies across the scheme,” he comments.
The headquarters of Railpen overlooks one of London’s busiest train stations, Liverpool Street, with trains shuttling between London and its suburbs, and the north and east of England. But today, UK corporates hold less of a sway in terms of where Mr Hitchen assesses value and upside for Railpen, and a gradual shift from UK quoted equities to US, the Far East, Japan and emerging markets has followed.
“A few years ago, I would be able to walk to our investment managers in the City of London, however (reflecting the scheme’s migration into non-UK equity houses) this no longer holds true. Now our managers are based all over the world,” he says.
“The regional mix of the fund has changed progressively and by the end of 2007 comprised 30 per cent in the UK and 70 per cent overseas,” Mr Hitchen says on how Railpen’s £11bn Global Equity Pooled Fund (GEPF) – over half of total assets – has evolved.
“Against our peer group we are underweight UK and overweight the rest, but I’m very comfortable with that. One worry I had was if we stayed primarily in UK equities, it may not perform well, so why just concentrate there,” he adds.
Diversification
Diversification was the watchword of Paul Myners’ review of UK institutional investment, which was published in 2001 when Chris Hitchen was Railpen’s then investment director. Was the report a signal to Railpen that it should begin to increase asset allocation to investments uncorrelated with bonds/equities, such as private equity and infrastructure? “For the UK pension fund industry, Myners was a wake up call and helpful in developing good practice, but bigger drivers for us were what our peers in North America and Europe were doing,” he says.
Railpen has moved to a different decision making structure in the past year, which Mr Hitchen says is tantamount “to moving to a type of internal investment management”. Similar to pension plans in the US and the Netherlands, with their in-house fund houses building up internal portfolios, Railpen’s investment committee “owns its own decisions and is now willing to delegate more”.
Mr Hitchen is eager to stress that Railpen has always had ‘alternative’ investments, pointing to private equity (beginning in 1987) and a series of investments in works of art - perhaps more esoteric than a pure alternative switch - which were undertaken in the 1970s as a hedge against rampant UK inflation (index linked gilts didn’t exist then).
“The trustees at the time would admit they bought badly but sold well – certainly the Impressionist paintings appreciated in value,” he adds. Returns of 4 per cent (plus inflation) a year were achieved through the scheme’s art portfolio which has whittled down to just one, a 17th century Mughal Indian painting which hangs in the reception of Railpen’s offices.
According to Railpen’s last annual report (published mid-2007) it had 37 external investment managers. Blackstone Alternative Asset Management, Grosvenor Capital, and The Rock Creek Group manage Railpen’s hedge fund exposure, while global equity mandates mop up a good deal of external business. He says: “We have £10bn in quoted equities and that’s an awful lot of money not to be divided up between external managers, unless run passively. We try to achieve exposure to different strategies in different regions so end up with a number of managers.”
Nordea, the Swedish investment house, and F&C Management have since lost equity mandates and the conclusion to Railpen’s actuarial valuation this year, “will likely see a trimming of the sails,” he says. “We will continue the trend of alternatives, and being underweight UK equities/overweight global.”
Ten investment managers take care of the private equity pooled fund, valued at around £1.6bn. A £1.5bn property pooled fund is managed by Orchard Street Investment Management and includes shopping centres, retail parks, and property on Pall Mall and The Strand.
There are asset classes where Railpen doesn’t diversify as much. For example Prudential M&G is solely responsible for roughly £1bn sterling invested in index linked bonds. “It is ‘horses for courses’ and partly a nod towards where we think we can gain alpha through investment management,” he explains.
Refreshingly after an hour with one of the most influential pension fund chiefs in Europe, there was no mention of the current credit conditions, although when pressed on the issue of using derivatives (earlier this month the Financial Services Authority cautioned their excessive use via 130/30 funds), the topic was raised: “Derivatives are not an issue but it pays to keep it straightforward whenever possible. We have safety guidelines in place and it's up to our investment managers to persuade us if they want to deviate from these guidelines. For instance, CDOs were structures that we routinely excluded from our portfolios and it was down to our managers to make the case to invest in them, and unsurprisingly no one did.”
Railpen has been a prime mover in establishing best practice for corporate governance (note the Calpers factor coming into play again) and recently launched a research project to look at how investors can profit from climate change, along with the Universities Superannuation Scheme (USS).
“We hope it’s not only commendable but actually to our financial advantage,” Mr Hitchen says. “Fund managers add value in a short to medium framework, however if
companies are better managed in the long-run, then you can get better long-term returns from them.”
