NEST, the UK’s £36bn (€42bn) defined contribution (DC) master trust, this week granted a thematic equity mandate to Lombard Odier Investment Managers (LOIM).
This strategy aims to benefit from the system changes resulting from the move towards sustainability.
It includes important themes such as climate change mitigation and adaptation, natural capital, and social issues. Chief Investment Officer Elizabeth Fernando explains: “If you’re going to invest for 60 years, you need to think about a company that will continue to provide the income you need to pay your pension over that time.”
Its aim is to invest in companies that have sustainable business models and operate in a manner consistent with government policy.
This obligation is estimated to reach £5 billion by 2030, demonstrating NEST’s growing influence in the UK institutional investment market. It is expected to grow to £100bn by the end of this decade, making it one of the UK’s largest pension schemes.
Therefore, given that NEST has signed the Mansion House Compact to invest at least 5% in unlisted assets and infrastructure, its investment strategy has important implications not only for its beneficiaries but also for the UK economy as a whole. Masu.
While overall asset allocation is handled by NEST’s own small investment team led by Fernando, the actual management of all assets is outsourced to 20 investment management companies.
Relative attractiveness of asset classes
NEST members can choose from six investment strategies, but more than 98% of contributions go into a set of retirement day funds that gradually shift asset allocation toward lower-risk assets as individuals approach retirement. Masu.
Unlike many such funds, NEST’s investment team also considers the relative attractiveness of different asset classes over the long term, so asset allocation is not a simple decision between stocks and gilts.
As a result, when quantitative easing forced Gilts to yield artificially very low yields and the index-linked Gilts had negative real returns, NEST had little exposure because it moved to higher-yielding corporate bonds instead. This put members in a good position during the gilt market collapse in 2022, Fernando says.
Other funds offered by NEST include high-risk and low-risk options, retirement funds, ethical funds, and Shariah strategies. The fund’s return profile over the past five years has been broadly in line with expectations, with funds with a retirement date in 2040 returning 8.0% annually, high-risk funds returning 8.6% annually, and low-growth funds returning 1.4% annually. was. . The obvious exception is Sharia funds, which come in at a staggering 16.7%.
The explanation, according to Fernando, is that the fund is significantly overweight in tech stocks, given any exclusions imposed by Shariah compliance, and has benefited from the significant outperformance of major U.S. tech stocks. It is said that he received the following.
There is also a downside to this. “It is not clear whether those who choose to follow the Islamic faith should be forced into the riskiest portfolios we offer,” Fernando said, adding that the fund currently has ample size. He added that the CIO is raising funds. The potential to create more diverse portfolios that better serve the needs of those who choose to invest.
Mansion house compact
NEST’s status as a pension scheme representing a third of the UK workforce means that it probably has a responsibility beyond just securing the maximum pension for its members.
“Thanks to our members, we have a real stake in the UK economy, which is performing well and creating many good, well-paid jobs. That’s why we support businesses that achieve that aim. I think we should,” Fernando said.
But as long as they can generate the profits they need for their members, it doesn’t really matter whether those companies are headquartered in the US or the UK, whether they are publicly traded or privately held.
However, around a fifth of the total portfolio and 40% of the private market allocation is in the UK.
NEST already has sufficient exposure to infrastructure and renewable energy, so becoming a signatory to the Mansion House Compact, which allocates a minimum of 5% of its funds to private equity by 2030, was not out of the question. , as Mr Fernando pointed out, the compact required the assets to be located in the UK.
Additionally, although NEST is not currently active in venture capital investments, Fernando believes that the risk of permanent capital impairment is too high compared to the private equity growth phase, which has been the focus of the company so far. There is.
For NEST’s asset allocation team, key questions relate to both long-term valuations and short-term fundamentals. Gilt was not attractive as a long-term investment when it yielded 1%, but it has value at 5%. Not surprisingly, the United States tends to dominate their analysis.
“A lot of the research we’re doing and thinking about is what the Federal Reserve is going to do because the trajectory of interest rates is a really interesting question over the next 18 months or so,” she said. explains.
As Fernando points out, the consensus was that the world would go into recession in 2023, but that didn’t actually happen. While it may be unrealistic to always do the right thing, Fernando worries about disappointing people. “Making the wrong decision could mean a better outcome or a better retirement than someone expected.”
For NEST’s 12 million or so members, that may be a comforting thought.