It was great to attend the recent Corporate Adviser Summit 2022, where I ran an interactive workshop on the future of investing in default funds.
The session focused on how investment strategies have performed over the past 10 years since the launch of auto-enrolment and how they will likely need to change over the next decade, considering the rapidly changing financial environment we find ourselves in.
A key change is that we’ve moved from a feast of central bank support to a famine.
In 2012, markets were still recovering from the lows of the Global Financial Crisis when Mario Draghi, the President of the European Central Bank, gave a speech that ushered in a period of quantitative easing across the Eurozone. This created a significant tailwind for risk assets across the globe.
Quantitative easing lowered interest rates, forcing investors into relatively more risky assets to seek returns. It also allowed companies to borrow more to expand and invest in their businesses. Pension schemes, therefore, benefited from a prolonged period of loose money, creating perfect conditions for equity investments to deliver above average returns.
A simple equity-bond strategy could provide members with strong returns, but now that the era of quantitative easing has ended, we need to create more dynamic investment strategies with a broader opportunity set that will continue to target positive returns for members in an era of contractionary central bank policies.
The likelihood of further rate hikes to quell burgeoning inflation will restrict risk appetite and lead to decreasing returns for traditional assets such as equities and bonds compared to the returns achieved over the past decade.
This doesn’t mean we need a complete revolution. Equities and bonds will continue to be cornerstones of most investment strategies, but we do need to evolve our approach and integrate other assets into our strategy to continue to generate positive returns.
Over the next decade, we expect:
- central banks to adopt less expansionary policies
- inflation to settle at a higher level as the disinflationary benefits of a decline in globalisation have largely run their course
- escalating geopolitical risks fuelled by rising nationalism, which will likely increase market volatility compared to the previous decade.
For DC investment strategies, market returns alone are unlikely to be sufficient, and schemes will need to work harder, smarter, and better manage risk. To continue to deliver positive returns for our members, we’ll need to expand the number of assets we invest in. So, what do these other assets look like?
At The People’s Pension, our size and scale as the largest independent master trust in the UK allows us greater scope to access alternative investment strategies. This might include investing in illiquid assets with returns based on the term and amount of capital loaned.
Already, around 13% of our default investment option invests in real estate and infrastructure. Both these asset types contain features of equity and bonds since they participate in the advantages of economic growth and pricing power while also earning income.
We’ll also need greater awareness, measurement, and management of tail risks. One of the most useful strategies now is environmental, social, and governance (ESG) data. Over time, we think ESG will become even more important to investment strategies. Measuring, understanding, and acting on ESG and climate data will be a key risk mitigation tool over the next decade and beyond. The feedback from my workshop highlighted that this is a view shared by the wider industry, where the majority of advisers in attendance stated that their clients are now taking ESG and climate risk seriously.
We should celebrate the success of auto- enrolment over the past decade, but we can’t rest on our laurels. Schemes must adapt to the current investment environment, where scale and resources will be crucial. Over the past decade, we’ve grown from zero AUM to £17bn+ AUM. As our asset base increases, we’ll continue to expand our investment team to access alternative risk premia in addition to traditional market beta and utilise new data sources to better understand and react to emerging financial material risks for the benefit of our members.