Asset Liability Modelling and Pension Schemes: the Application of Robust Optimization to USS

This paper uses a novel numerical optimization technique - robust optimization - that is well suited to solving the asset-liability management (ALM) problem for pension schemes. It requires the estimation of fewer stochastic parameters, reduces estimation risk and adopts a prudent approach to asset allocation. This study is the first to apply it to a real-world pension scheme. We disaggregate pension liabilities into three components - active members, deferred members and pensioners, and transform the optimal asset allocation into the scheme’s projected contribution rate. The robust optimization model is extended to include liabilities and used to derive optimal investment policies for the Universities Superannuation Scheme (USS), benchmarked against the Sharpe and Tint model and the actual USS investment decisions. Over a 144 month out-of-sample period robust optimization is superior to the two benchmarks on all the performance criteria and has a remarkably stable asset allocation – essentially fix-mix.