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NEST CIO warns of ‘regret risk’ in alternative indexing

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Mark Fawcett, CIO at the National Employment Savings Trust (NEST), has warned of “regret risk” when investing in alternative indexing.

The state-backed defined contribution (DC) master trust has around £162m (€205m) in assets and recently announced two emerging market equities mandates using alternative indexing.

It also amended its investment beliefs to mirror a move towards alternative indexing, suggesting index investing will in the long-run provide better returns in terms of risk, return and cost than active management.

It had amended its previous statement that passive investing was generally superior to active management.

However, Fawcett told IPE the fund simply wanted to acknowledge alternative indexing could be a good and cost-effective way to manage investments.

“One of the biggest risks about alternative indexing is the regret risk,” Fawcett said.

He warned against immediately comparing alternative index returns to market capitalisation returns.

“People can fall into the traditional story of going into something that then underperforms,” he said.

“We were very careful when we made our emerging market decisions not to be just chasing success.”

The fund has a 1.5% allocation to emerging market equities thus far, but Fawcett said the procurement was now in place to allow it to move to market, or overweight, when the internal team deemed it appropriate.

Despite the recent foray, NEST’s internal asset allocation team said it was not looking to make the default investment fund overly complex.

“We’re not looking to make this complex because that’s interesting and fun,” Fawcett said.

“As we get bigger and more sophisticated, managing the dynamic risk allocation will be more important.”

Fawcett did concede that recent Budget changes could force the UK’s largest master trust, with more than 1m members, to develop more complex fund choices for members.

It will research possibilities for low-cost drawdown given the current strategy is aimed purely at annuitisation – a product expected to diminish given the DC at retirement freedoms from April 2015.

Fawcett will evaluate the default investment strategy, and the appropriateness of target-date funds for members approaching retirement.

Some 99% of NEST members are currently invested in the default strategy despite additional options for ESG, low-growth, higher-risk and Sharia-compliant funds.

“The default strategy will remain important, but we may offer some choices alongside that, and they do not have to be target-date,” Fawcett said.

“We are thinking around post-retirement date funds. But we are trying things out and are not close to decisions.”

Seperately, NEST will consider offering the building block funds of its default investment strategy as individual options for members.

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