NEST exec mulls broader asset mix
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June 09, 2014 01:00 AM

NEST exec mulls broader asset mix

Skyrocketing growth will provide scale for moves into alternatives

Sophie Baker
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    Mark Fawcett said he's 'happy to be patient' but would like to invest in infrastructure at some point.

    Mark Fawcett, the man at the helm of investment at what could become the U.K.'s biggest defined contribution plan, is looking closely at potential shifts in asset allocation — including expanding its roster of investments.

    “While we have quarterly asset allocation meetings, we typically only significantly change asset allocation about once a year,” Mr. Fawcett, chief investment officer, of the National Employment Savings Trust, London, told Pensions & Investments in an exclusive interview at the Southwark, England-based offices of NEST Corp., which manages the plan.

    The £120 million ($200.8 million) DC plan is looking at new allocations right now. But the key to some of these opportunities, he says, is scale.

    That doesn't look like too much of a challenge, for a plan that has grown 2,300% since this time last year, when assets were a meager £5 million. And with a general consensus that the plan could grow to as much as £200 billion by 2050 — a figure that a NEST spokeswoman said would depend on a number of factors, including membership and contribution levels — that should be no problem.

    “We are looking at infrastructure at the moment, but as there is an advantage to having scale, we are happy to be patient. To get into infrastructure, you need significant size — we are not desperate to invest, but we would like to get involved at some point,” Mr. Fawcett said.

    Mr. Fawcett has been CIO for six years — first for the Personal Accounts Delivery Authority, the name for the government-created DC plan for lower-income U.K. workers between 2008 and 2010. PADA then became NEST. It started taking on participants in 2011. He has kept a close eye on liquidity.

    “We are not invested in bank loans at the moment because of illiquidity,” he said. “It's not about tying up the money, but getting the money into the asset class.” That concern over being able to actually invest assets to an allocation the growing fund would like also applies to infrastructure. Mr. Fawcett said he and members of his 16-person investment team are talking to infrastructure managers “and trying to work out how we can get a situation where cash flow can be absorbed more easily.”

    It might be, Mr. Fawcett said, that the plan takes a similar approach to its investment in real estate: “We have a listed and unlisted split, and the listed investment takes on cash flow until the unlisted side is ready to invest it.”

    NEST is also about to appoint two managers for new emerging markets equity allocations. The allocations to emerging markets debt and equity vary depending on which of three phases a participant is in. The spokeswoman said there will be an increase in these allocations, and the plan's investment team is modeling what that optimal allocation should be for each phase.

    “Our emerging markets exposure right now is through a BlackRock diversified beta fund, a multiasset fund investing in passive trackers,” Mr. Fawcett said. “We only have a small exposure to emerging markets through that fund. Adding new mandates is a way to manage our exposure to this asset class more actively.

    “Emerging markets have been underperforming recently, so it has been OK to be underweight. But they are getting cheap now, so we want to have the ability to increase our exposure over the coming years.”

    One of NEST's biggest changes to its asset allocation came in October 2012, when the investment team ramped up its portfolio risk.

    “When we launched in 2011, we had pretty low equity exposure because of the eurozone crisis. Our equity weighting (in the growth phase portfolios) had been around 40%,” Mr. Fawcett said. But in October 2012, the team increased its equity weighting to more than 50%, and also added corporate bonds into the mix. “We also sold virtually all of our U.K. gilts as we thought they were overvalued,” he said.

    As for other allocations, Mr. Fawcett said it is “challenging to think we might ever invest in hedge funds or private equity — is it necessary?” He said fees — something NEST keeps a close eye on, with its 0.5% annual management fee for most participants — prohibit this. “In a hedge fund, you might get some beta and alpha, but is it worth paying two and 20 for that? I think not really,” he said, referring to the typical 2% management fee and 20% of profits hedge funds charge.

    Similarly, he said, private equity can deliver “really good value, but if you're not in a top-quartile fund, you may as well be invested in public equity.”

    Different structures

    The plan is made up of about 50 target-date funds, the NEST Retirement Date Funds. These funds are annual, reflecting a view of a certain year of retirement for participants — leading up to the point when they were expected to annuitize. Mr. Fawcett said that is different from the typical U.S. structure, where target-date funds are split into five-year groupings. He said NEST's structure is “easier to communicate to members” that way.

    NEST does not have an overall asset allocation per se — rather, it is made up of three different phases: the foundation phase, for younger members, up to about age 30; the growth phase, for those age 30 to 54, where participants will spend the most years; and the consolidation phase, which kicks in about 10 years prior to a participant's retirement, derisks from volatile and risky investments and into annuity-tracking assets. Using typical funds in each phase, the changing risk tolerances of a sample of asset classes are obvious.

    nThe foundation phase allocates 28.9% to developed market equities; 20.3% to money market investments; 14.2% to U.K. investment grade bonds; and 3.5% to U.K. gilts.

    nThe growth phase allocates 45.6% to developed market equities; 5.7% to money market investments; 13.1% to U.K. investment grade bonds; and 3.5% to U.K. gilts.

    nThe consolidation phase allocates 30.8% to developed market equities; 11.9% to money market investments; 21% to U.K. investment grade bonds; and 14.7% to U.K. gilts.

    The foundation phase is different. It targets inflation after fees, and has a typical equity exposure of just 30%. “That is slightly controversial as everyone thinks you should take risk when you are very young,” Mr. Fawcett said. However, the plan found that participants were “very risk averse. The amount these participants have invested is so small it almost doesn't matter how much risk they take — it is when the pot is bigger that the amount of risk taken starts to really matter. Our analysis found that a sure-fire way to get a bad income in retirement is to stop saving when you are 25.” n

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