Jonathan Williams finds out how the UK's National Employment Savings Trust is setting out to encourage new members to join
How do you make pension-saving attractive for workers who have likely never had a pension? The challenge faced by the National Employment Savings Trust (NEST), one of the cornerstones for the introduction of automatic enrolment in the United Kingdom, was no small matter. After years of debate, the new scheme's statement of investment principles was unveiled in late March, with its management team eager to address many of these concerns.
Unusually for a defined contribution (DC) pension fund, its stated goal for new members' first handful of years is not necessarily to increase the pension pot, but simply to maintain it and allow it to grow in line with inflation. During this time, which lasts until the member is around 30 and has been branded the foundation period, NEST will adopt a low-risk approach for its default target-dated fund and simply seek to increase the small pot in line with the consumer price index (CPI), raising the investor's risk profile year on year as the payout date approaches.
The notion is that in these first few years, it is more important for members to adjust to the idea of saving and that any significant losses during this time will only serve to drive away these likely financially inexperienced members.
Chris Hitchen, a scheme trustee and chair of the investment committee explained the approach: "By the time they reach age 30, we think they will be used to saving - frankly, they will be reaching a stage where we need to be earning some real returns - but in the foundation phase, we're not trying to do that."
However, there was criticism of this low-risk approach in some areas, with Hymans Robertson warning that some employers would look elsewhere for pension provision.
The consultancy's head of DC, Lee Hollingworth, said that NEST's one-size-for-all approach, regardless of the payscale of members, would lead to some companies considering more "tailored" options. "This will focus on delivering the required outcome at retirement, such as defaulting groups of members into different funds according to contribution levels paid and earnings profile."
The real returns Hitchen alludes to are targeted at CPI plus 3% per annum which, at any other point in the last decade, might not be considered ambitious. However, at the time the announcement was made, CPI plus 3% amounted to growth of over 7% per annum in a market environment where many critics still raised questions over long-term stability.
Hitchen said he was glad that the scheme was not launching three years ago, when the economic crisis would have damaged the scheme's chances of achieving its targets. However, other critics viewed the 3% goal as too low.
Chief investment officer Mark Fawcett was quick to defend the target. "I think CPI plus 3% certainly puts us in a place of a reasonable amount of risk, but less risky than maybe other top funds."
Of course, how these returns would be generated was also an unknown until recently. While details about the scheme's portfolio were revealed late last year, the exact asset allocation remained a mystery. It has since been confirmed that the default fund, when in the foundation period where it only aims to match inflation, will be heavily invested in both sovereign and corporate bonds, with around 30% allocated to this asset class for someone 47 years away from retirement. A second, still sizeable chunk, is invested in developed market equities while another third is held in cash. At this early a stage, only trace amounts of money are allocated towards property or emerging market debt.
This cautious approach was not welcomed by all in the industry, with Mercer's Brian Hederson, the consultancy's European head of defined contribution pensions, noting: "The challenge will be taking care not to undercook the low-risk start, especially in light of the initial charges."
"Without sufficient growth to overcome the initial entry fees there is a potential risk that the early year low-risk foundation stage could linger," he continued.
In stark contrast to this is the asset allocation NEST expects to implement for one of its fund options for those who choose to manage their savings actively. Members invested in the NEST Higher Risk fund will see around 75% of assets exposed to developed market equities, with a slight exposure to the emerging market stock and property. The remainder is allocated to inflation-linked bonds, as well as emerging market sovereign debt and other bond markets.
Additionally, even those not invested in the ethical fund will be exposed to certain areas of socially responsible investment, with the scheme declaring its intention to become a signatory to both the UK's Stewardship Code, as well as the United Nation's Principles for Responsible Investment, in an attempt to be a "good corporate citizen".
This goal would predominantly be achieved with the help of a responsible investment overlay, despite its passive investment approach, with Fawcett explaining that the overlay would help the scheme practice management so that when it was ready to manage separate portfolios and vote on shares, it would have the necessary expertise.
Fawcett would only say that he hoped to eventually add separate portfolios for some areas, but as the scheme refuses to predict how large it will grow to be over the next few years, it is impossible to tell how quickly this shift will happen. All that is known, so far, is that large employers will be part of a soft launch, in an attempt to encourage the uptake of auto-enrolment.
Once individual asset classes become viable, the chief investment officer hopes to explore other asset classes in more depth. "Corporate bonds and real estate would certainly be very much on our radar," he said. Currently, its diversified beta fund, managed by BlackRock, is its only source of real estate exposure.
Despite all that was unveiled by NEST in March, there are still several important questions lingering. As there are no concrete figures regarding membership, no assumptions can be made about how its assets under management will grow in the coming years, which again limits to speculation any assumptions that can be made about its footprint in the UK market.
Many seem hopeful that it will improve membership communication across the DC sector as it becomes a leader in the field, with its stated aim of simplifying investment jargon, others hope that its commitment to socially-responsible investment will encourage schemes in the UK to follow suit.
However, until we know if the scheme will sink or swim, all that we are left with is speculation.