Liz Fernando has favoured an evolutionary approach as Nest CIO while the DC sector grapples with some of the
most fundamental changes for a generation. Emma Simon hears how this is shaping its investment strategy
It is now just over three years since Liz Fernando took over the role of chief investment officer at Nest, the UK’s largest master trust.
These last three years have seen a number of significant changes across the DC landscape, with the shift towards private market investments, and a new focus on the decumulation options for DC savers, both of which have a direct impact on investment strategies.
Fernando says both have been a major focus for Nest in recent years, although Nest’s strategy to diversify into private markets pre-dates her CIO role.
Fernando characterises her tenure as CIO as one of evolution rather than revolution, perhaps not surprisingly, given she was previously head of long-term investment strategy and then deputy CIO, in both roles working closely with the previous CIO, Mark Fawcett.
She says: “Mark’s obviously still with us [as CEO of Nest Invest]. I’ve taken on the more exciting bits of the job and he’s got the more mundane aspects of running a business.”
These more exciting elements include the expansion of Nest’s private market capability, which saw it take a 10 per cent stake in IFM Investors- the private market asset manager owned by a consortium of Australian
superannuation funds – last year.
Fernando explains that Nest has a longer-term ambition to have around 30 per cent of its aggregate portfolio in private markets, although she points out that younger members will have a higher allocation because of their capacity to take on the illiquidity risk inherent with these assets.
She points out that unlike other DC workplace schemes, which are now looking to ramp up investments from a standing start, Nest has been active in this sector since 2019.
Fernando says this includes a significant allocation to UK real estate (both commercial and residential), alongside a renewable and infrastructure portfolio which is orientated towards the UK and Europe. She says there is more of a US bias to the private equity allocations.
“This isn’t exclusively in the US though. We have given Schroders and HarbourVest a sleeve of money
specifically to hunt for UK opportunities.”
Nest also has a timber allocation, currently wholly in North America, with a view to expand into Australia and New Zealand. There is also a private credit allocation,which recently involved a significant investment into the US, via the appointment of Crescent Capital Group to run a £450m mandate, which includes loans to US tech
and healthcare companies.
This announcement came at a time when there were some concerns about how Al could impact the valuation of many technology companies going forward. Was Fernando worried about this when awarding the mandate?
“I’m not uncomfortable with the fact that we are going into the market at a point where other people are trying to get out of it because that means we’ve got less competition for really good assets.
“You’re more able to dictate terms and pricing and covenants when there’s not lots of money trying to get into the same opportunities at the same time.”
Key to this, she says, is working with high quality partners who will “kick the tyres” on the investments that they choose to make on your behalf, and on those they choose to walk away from. She says this applies to Crescent, which has a good track record of conservative underwriting, and taking a controlling position in the lending it undertakes.
“They get great visibility and access to the management of the teams they are backing.”
She says such principles apply to both public and private asset managers Nest works with. Although there is much talk about the potential to deliver better member outcomes by diversifying into private markets, Fernando says selecting the right private market investments will be key.
“I think it’s also important to state that just because something carries the label ‘private markets’ doesn’t mean that you should automatically get a superior return.”
She adds: “This is why our procurements take us a long time because we think it’s really important to be turning stones over to ensure we are not going to be surprised by things further down the line.”
Mansion House commitments
If Fernando can see the advantages of moving into US private markets at a time when others are exiting, does she see potential disadvantages with DC schemes moving on mass to invest in UK private markets, in a bid to meet Mansion House commitments? Could this lead to overvalutions of certain assets?
She says this is a concern, given the high number of schemes that are just starting to invest into this area. “I’m very glad we started our private markets programme back in 2019 rather than starting it now,” she says. Fernando points out that two-fifths of Nest’s private markets portfolio is now invested in the UK.
While Nest will build on these investments, it is not forced to do so at the rate of some competitors. “I’m sure every scheme will try to be disciplined and diligent in who they’re appointing and how they’re getting money to
work. But it is the law of supply and demand: if there’s more demand and the supply doesn’t shift, all that happens is prices move.”
But she adds that it’s important to remember that as part of the Mansion House commitments the Government is also working to help increase the pipelines of suitable opportunities, which she says should go some way to potentially address this issue.
Rethinking glidepaths
This shift into private markets is also helping Nest recalibrate its glide path to a certain degree. Nest stands out from other DC master trusts in the market, by operating a more unusual glide path, with an initial lower risk ‘foundation’ period, before moving into the standard growth phase, and then – more conventionally – derisking over 10 years to a retirement portfolio.
Fernando says one of the biggest changes made in recent years has been to revisit the overarching objective of the default strategy, where 98 per cent of members are invested.
“Initially this was focused on growing pots during the accumulation period and sending people off into retirement with a good pot of money behind them.
But it became very clear from conversations with members and all the research we were doing that people felt a pension should give them an income in retirement, rather than just being handed a pot of money. For the past four years our objective has been to provide the best retirement income for as many people as possible, of course recognising that the size of the pot is the biggest single determinant of this.”
This she says has changed the approach to asset allocation under the hood, with Nest building five portfolios that reflect some of the key objectives highlighted by members, be it delivering a more certain income in retirement, being able to use their pension like bank account, concerns around volatility, but also being comfortable, when younger, to lock away their funds for a long period of time.
“We look at the potential risks and probabilities of not meeting these key goals and have moved away from just using volatility as a shorthand for risk. We now use a total portfolio approach when constructing the default strategy, and look at asset allocation across these five building blocks over time. It’s more of a continuous evolution of different assets coming in and out at different points, rather than this very angular three-phase approach.
However this doesn’t mean Nest has completely abandoned the foundation stage which has received criticism from consultants in the past, for putting younger savers into lower risk assets. “The foundation phrase is still in our dictionary.” Fernando explains. “But the difference is we recognise young members have the biggest capacity to take on illiquidity risk.”
“Private market investments offer some of the same attributes as bonds and other less risky investments – in terms of stability of pricing – but the returns are much better. So we can offer these same characteristics to younger members without sacrificing returns.”
Decumulation strategies
This new approach also feeds into Nest’s decumulation strategy. The government recently amended Nest’s order, which will allow it to expand the range of retirement options offered, to include flexi-access drawdown. It is
also exploring a new retirement product with Rothesay which will ensure it meets new requirements to offer a default income solution.
The product, which is still in development, will offer default retirement pathways, which will include a bulk annuity element (offered through Rothesay) from the age of 85.
“This is still in development and will offer default retirement pathways of which Rothesay will be one component. The aim will be that we glide members in the pre-retirement default strategy straight into this, so there should not be any funny discontinuity in the risk profile.
“We would aim to do the same thing as we do now, but land at the starting portfolio for what we are calling ‘the blueprint’ for this new product.”
She says while they don’t currently know what the exact starting investment portfolio will look like “our current best guess is that we might actually have a little more risk in it than the current guided retirement fund, because of that Rothesay element giving certainty of income beyond 85.”
There isn’t an exact timetable to launch, but Fernando confirms that this solution will be ready to go live with the new regulations, but if it is ready to launch earlier it will be, to benefit members.
Herding concerns
When it comes to current risk attributes Nest already takes a slightly more risk-on approach than some of its competitors for savers five years from SPA and at-retirement, helping it to post above average returns for these stages in the most recent CAPA data survey.
Fernando says she was unaware how Nest’s asset allocation differed from competitors at this stage. “We build portfolios we think meet our members’ needs, rather than looking at what others are doing in the market. I didn’t know we were different to our competitors at that point in the journey.
“The thinking behind our consolidation phase is that it gets people to a portfolio that aligns with the one they would hold with us postretirement if they were to go into the Nest guided retirement fund.”
She adds Nest is cognisant that not all members will do this, either because their pot size isn’t big enough, they have DB savings so will take cash, or they will be consolidating savings into other schemes. But she says the size of Nest and its positive cash inflows are a huge advantage here.
“We can effectively set up an internal market between members who are not staying with us post-retirement, so assets can be bought by younger members, and we are not forced sellers of assets. In that way we can probably run more risk in the portfolio.”
Fernando is clear that as CIO decisions should be made based on members’ needs, rather than looking at what others in the market are doing.
Does she think the new value for money framework,which will include performance tests, might encourage schemes and the CIOs who set the strategy, to start paying more attention to what their peers are doing?
She says this is is always a potential risk. “I think in Australia we’ve seen more herding around asset allocation as a result of similar legislation being introduced. The UK has learned from this though and the VFM framework is using slightly longer horizons than the Australian model, which may mitigate this risk to some degree.
“We are trying to deliver the investment returns members need to meet retirement objectives. Making investment decisions while looking over your shoulder at what others are doing isn’t a sensible way to run a portfolio, in part because you will only know with hindsight what someone else did. You don’t drive cars staring in the rear-view mirror. It’s the same here, we should be focused on future expected returns from different asset classes.”
She says that if VFM means schemes no longer feel obliged “to stick it all in cheap trackers” this will be a good thing for members, particularly if it encourages greater diversification. “Focusing narrowly on cost can lead to some odd allocation decisions.” she adds.
Fernando joined Nest in 2020, from the Universities Superannuation Scheme where she worked for more than 14 years. She says she can see a number of parallels between the two organisations, although some significant differences as well.
“When first joined Nest it very much reminded me of how USS was when I started there. It was initially a very small investment team, not the behemoth it is today.” She says she gained valuable experience working
for an investment company that was rapidly scaling and expanding its investment expertise, both in relation to private markets and looking at issues around sustainability and responsible investment.
One key lesson from USS she says is the importance of efficient governance and avoiding overly convoluted decision-making. “Over time the governance there did become quite convoluted so getting decisions made could be quite challenging.”
She adds: “The beauty of being a relatively young scheme and growing up after lots of others is that Nest has been able to learn from other pension organisations both in the UK and overseas.
“One of our key advantages is our size and scale,” she says. “We regularly go out and talk to peers on a range of different topics asking what worked and, more importantly, what they wish they could have done differently.”
Fernando says that while it can be challenging to run a scheme of this size, and with such a diverse membership, she says it remains a privilege to be in this position.
“The members are at the heart of what we do and aim to keep them central to all investment decisions.”
