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NEST launches 'relatively cautious' emerging market strategy

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The UK National Employment Savings Trust (NEST) has begun to shift assets into emerging markets by passively allocating to ESG focused and alternative index funds.

The £162m (€203m) defined contribution (DC) master trust will initially allocate 1.5% of its growth phase fund towards emerging market equities.

Mark Fawcett, CIO of the fund, said NEST and its managers saw attractive value despite emerging market equities not performing recently.

The government-backed auto-enrolment provider said in 2013 it would search for an emerging market manager to boost growth and diversification within its default fund.

For passive emerging market equities, it selected Northern Trust Asset Management’s ESG-focused, market-cap-weighted fund, and HSBC Global Asset Management’s alternative index economic scale fund.

Both funds will be blended within NEST’s target date fund and not be offered individually to members.

“We will start relatively cautiously – about 1.5% of the growth phase portfolio – and we will build this up significantly throughout the year,” Fawcett said.

“If we see severe undervalue, we could go to relatively higher weightings. The neutral position will be about 5% if we have 50% in equities.”

Northern Trust AM’s ESG fund screens out around 10% of the global emerging market index based on sector exclusion and ownership structures, which NEST said would provide greater risk-adjusted returns, with a momentum style bias.

The fund from HSBC GAM is a fundamentally weighted vehicle based on the economic footprint of companies, which rebalances and provides a small value bias, as well as returns based on what HSBC described as “excess volatility”.

Fawcett said the two funds offered different but complementary strategies, and that the blending and rebalancing of the two would provide a momentum and value trade-off, offering additional diversification.

A report by consultancy Towers Watson highlighted correlations between ‘alternative beta’ strategies such as value and momentum could provide pension funds with additional diversification benefits, despite being invested for returns.

It showed that having an equity strategy against a value strategy within a hedge fund showed returns had a correlation coefficient of -0.22, boosting diversification.

Fawcett said playing off the value and momentum strategies offered by the two funds was integral to NEST’s selection.

“There will be times one outperforms the other, but we will rebalance between the two for additional improvements in risk-adjusted returns,” he said.

He also said the fund was still looking into infrastructure debt funds.

However, given the relatively small size of the fund and the initial costs of entry, the team is in no rush to enter the asset class, he said.

On frontier markets, Fawcett said NEST would not be looking to invest any time soon.

“Ultimately, one of the issues within emerging markets are governance concerns,” he said.

“Frontier markets are just another step into that territory, and we are not sure that is right for us.”

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