Mega-trends are at the front and centre of the National Employment Savings Trust’s (Nest’s) thinking when it comes to how it runs its money, with plans to increase tilts to climate aware equities and expand these to other asset classes.
Nest was setup by the UK government in 2010 as a default workplace pension scheme. As at March 2021, Nest had £17.2 ($31.4) billion in AUM, contributions of approximately £4.7 ($8.6) billion a year, a total expense ratio of 0.3 per cent, and a membership of 9.9 million people.
Unsurprisingly, for a young pension scheme, its membership is also relatively young. Mark Fawcett, Chief Investment Officer of the fund, estimates that the weighted average of age is probably in the early 30s. With youth on its side, the scheme has the luxury of planning its investments with an eye on the mega-trends that will shape the world over the next three decades.
“We really try and focus on that long term because we feel that is where our competitive advantage is. There’s no point in trying to compete with proprietary traders and investment banks in terms of trying to make asset allocation calls [for the short to medium-term],” Fawcett explains.
We really try and focus on that long term because we feel that is where our competitive advantage is. There’s no point in trying to compete with proprietary traders and investment banks in terms of trying to make asset allocation calls [for the short to medium-term]
When the scheme was founded in 2010, the typical default fund option was 100 per cent in passive equities with a big UK bias. The first decision was to remove the home bias as – unlike Australia – there was no tax incentive.
This meant the fund moved from a concentration in banks and resources to exposure to global growth sectors such as technology.
Subsequently, Nest added more asset classes and is now in private credit, short-duration investment grade bonds, emerging market equities and debt, global listed property, hybrid property, direct property, commodities, high yield bonds, sterling corporate bonds, gilts, and infrastructure equity.
But the centrepiece of the investment strategy is the allocation to ‘climate aware, global developed equites’ – the default option has a massive allocation at 52.3 per cent.
Climate Aware Investing
Currently, the climate aware investing strategy works through a range of tilts that overweight companies that are transitioning to a low carbon economy and underweights laggards or those that have a risk of stranded assets.
“We don’t divest companies generally. Our ambition is we would encourage mining companies to work out how they can transition to a low carbon economy. Copper, if not already, will become the world’s most important metal, because the world is going to have to be run on renewable electricity,” Fawcett says.
He adds this is not a static process and that the climate aware aspect of the scheme will only become stronger as it transitions to net-zero carbon emissions.
We look to Australia for best practice for so many things, such as investment in illiquids for defined contribution schemes – you're definitely leading. However, responsible investing is probably behind the Europeans
“And we’re now evolving so all of our asset classes will have some element of climate awareness going into them. The volume of that will increase in terms of…, we’ll increase the level of the tilts, we’ll increase the amount of divestment as we transition through to ultimately 2050 and net-zero, but the bulk of the work will be done in the next 10 years.”
While climate aware investing is the flagship, Nest constantly lauds the importance of being a responsible investor. The house view is that investing responsibly leads to better risk adjusted returns. Areas include good governance, diversity, no supply chain issues such as slavery or child labour, fair work practices, tobacco-free portfolios, and sustainable food retail and production.
“We look to Australia for best practice for so many things, such as investment in illiquids for defined contribution schemes – you’re definitely leading. However, responsible investing is probably behind the Europeans,” he says.
When surveyed, 73 per cent of members said they wanted Nest to invest responsibly and, interestingly, about half of those were willing to give up returns for that to happen, though Fawcett is quick to point out that this is frequently a false dichotomy; investing responsibly doesn’t always lead to lower performance.
Universal Owner
While Fawcett did not use the terminology, how Nest runs its money is linked to ‘universal ownership’. This idea dates to at least 2000 as put forward by economists James Hawley and Andrew Williams.
Universal ownership states that asset owners effectively own a slice of the economy. Therefore, it should be a responsible investor as if costs are externalised in one part of the portfolio, it will likely be worn in another part.
For example, minimising workers’ wages can increase companies’ bottom lines. However, at an economy-wide scale this is a problem because those same workers are also customers and there is now less money to spend which decreases companies’ profits.
“We have something in the UK called: ‘the living wage’, which is above the minimum wage. It’s about how much money people need to live at a reasonable standard of living, above the poverty line, and we are signatories to an initiative there, which is pushing all companies to pay the living wage, and we think that’s important. We think it’s good for society, good for the economy, and ultimately good for companies if they pay their workers well, as well as paying their executives fairly,” Fawcett says.
We have something in the UK called: ‘the living wage’, which is above the minimum wage. It’s about how much money people need to live at a reasonable standard of living, above the poverty line, and we are signatories to an initiative there, which is pushing all companies to pay the living wage, and we think that’s important.
As universal owners own a slice of the economy, it follows that their success is correlated to the long-term trends of the economy, which is itself predicated on a range of factors.
According to the research from the British Ministry of Defence, other mega-trends over the next 30 years include harnessing artificial intelligence, erosion of state sovereignty, increased competition for global commons, automation, demographic changes, and rising inequality reducing social cohesion and fragmenting societies, to name but a few. All of these will influence society and the economy.
“It is going to be really interesting but probably quite harrowing how some of this stuff is going to develop, really, because you look at what is happening, the impact of climate change is being felt already in Africa, et cetera. That will drive war and migration,” Fawcett says.
Head of Long-term Investment Strategy
He adds that he created the recent position of Head of Long-Term Investment Strategy to ensure that Nest is focused on the long-term themes that will drive the portfolio, and to guarantee the asset allocation process is geared up for that.
“Our capital market assumptions are market forecasts from one of the big asset managers. Their model works with different economic scenarios – and that’s great – but what we want to make sure is that we’re thinking about some long-term scenarios, which may not have been modelled, climate change being one of them, and thinking about: ‘Right, given that, how should we be evolving the investment strategy?’,” he says.
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