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DC/Hybrid Strategy - NEST

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The Young Pretender

Judge’s comment: “NEST remains at the forefront of the defined contribution market in Europe with its innovative strategies and, predominantly, its risk approach.”

The UK’s specialist auto-enrolment scheme has accumulated £500m (€696m) in just a few years. While NEST is currently small in terms of its assets, it is expected to grow considerably in coming years as the auto-enrolment gathers pace.. This means it needs to continue to take scale into consideration when it both delivers and refines its investment strategy.

NEST believes valuations are one of the core tenets of investment theory and thus it builds its reference portfolios using mean variance optimisation and risk parity models based on long-term capital market assumptions about expected returns and risk for different asset classes. But those are not the only drivers. NEST also strongly believes that volatility alone does not describe market risk and that expected returns can only be achieved when assets are purchased at, or preferably below, fair value. NEST therefore reviews its asset allocations on a quarterly basis, taking into account a large array of market and economic data from across asset classes and geographic regions. The fund does not believe in trying to take short-term bets, but will rebalance away from assets that reach unsustainably high valuations in favour of those it judges to be undervalued.

In addition to dynamic risk management, NEST’s belief in the importance of valuation is reflected in the procurement in July 2014 of a smart beta emerging market index fund managed by HSBC. In this fund, stocks are weighted by the company’s economic footprint rather than their market capitalisation. This means it has a de facto value-oriented style bias that should allow the fund to participate in the growth of emerging economies more efficiently.

In March 2015, NEST also began investing in 10 single-year-maturity Gilt funds to improve returns relative to cash whether they are still building up their pot or approaching income drawdown. For example, NEST Retirement Date funds in the consolidation phase each have an allocation to the relevant Gilt maturity that matches the target date on a buy-and-hold basis. This means members can enhance yield without exposing themselves to significantly greater duration or mark-to-market risk at the point when they take their pension. Thus, by aligning target date and fixed income maturities, NEST is able to improve member outcomes while carefully managing risk. These Gilt funds also give NEST the flexibility to manage the duration of its bond investments – a particularly important tool at a time of low yields and increased volatility in the bond markets.

NEST believes that in order to deliver the sophistication the scheme aspires to within its low-cost mandate, it must strike the right balance between ’buy’ and ‘build’. This is why the scheme retains a small but highly skilled investment team that manages core aspects of the investment strategy, from asset allocation and risk management to the development of ESG and the responsible Investment policy.

Beyond the 50 or so Retirement Date funds, NEST also offers a focused range of five alternative investment choices. These are based on insight into both the needs of members and employers. NEST argues that its options represent a clearer and more bespoke set of choices, rather than dozens of options clustered around a similar point on the comparative risk scale. It also offers alternative investment choices based on faith and ethical beliefs. Where it can, it tries to reflect the sophistication of its default investment strategy in these alternative options. For example, the NEST Ethical fund is diversified across different asset classes, follows a 46-year glidepath and its risk is managed dynamically in parallel with the scheme’s default target-date funds.

2014 Essentials

NEST

United Kingdom

Founded in 2011

Defined contribution multi-employer fund

Members:

  • active: 2,007,754
  • retirees: 1,554

Assets: €0.7bn

Performance

  • one year: 4.4%
  • three years: 11.7%

Quick facts

  • Procurement of a smart beta emerging market index fund in 2014
  • Allocation to a manager of 10 single-year government bonds maturities to track target date funds
  • Alternative ethical and faith-based investment fund choices

Short-listed

  • Almenni Pension Fund Iceland
  • Previsión Social, Empleados del Grupo Endesa FP Spain
  • SEB Pension Denmark

Judges

  • Patrick Ferguson
  • Nora Finn
  • Robert Gardner
  • Philip Menco

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