NEST’s chief investment officer Liz Fernando has said the UK defined contribution (DC) master trust is watching the bond market closely as the country prepares for the upcoming budget.
The scheme expects a challenging fiscal negotiation within the Labour party, with a mix of tax increases, spending reductions and potentially higher inflation deployed to address the deficit.
UK chancellor of the exchequer Rachel Reeves is due to present the budget on 26 November. Ahead of the 2024 general election, Labour pledged not to raise income tax, national insurance or VAT for working people, but the government faces pressure to either lift taxes or cut spending.
Against this backdrop, Fernando said in an investment update today that NEST is “watching long bonds very closely”.
She added: “We think they [long bonds] got to a very attractive yield earlier this month. We’re not confident that they’re quickly going to come back down again, but we do think they are beginning to offer very interesting levels of income to the portfolios.”
Yields on 30-year UK government bonds climbed above 5.7% earlier this month, their highest since 1998. Market commentators have linked the move to concerns over government finances and the additional yield required by investors to hold longer-dated Gilts.
NEST, which manages more than £55bn (€63.6bn) for 13.5 million members and 1.2 million employers, is tailoring its approach to bonds depending on savers’ stage in the retirement journey.
For older members, the pension fund avoids long-duration bonds in its capital preservation portfolio, preferring maturities of less than five years to limit capital risk. For younger members, however, it is prepared to take on longer-duration assets to benefit from higher yields.
Fernando said: “While yields rise, bond prices fall. If you’ve got new capital to invest and you are able to invest in those higher yields – that means you can pick up a very nice income from Gilts in the way you could not until 2022.
“We use bonds in different ways depending on where a member is on their journey.”
Equities also remain under scrutiny. Despite concerns about global growth and higher interest rates, markets have shown resilience.
“We are slightly surprised how resilient the equity market has been”
Liz Fernando, NEST’s CIO
Fernando said: “We are slightly surprised how resilient the equity market has been. Valuations are very elevated, although earnings during the first half of the year have been pretty good.”
She disclosed that NEST reduced its equity exposure last year, not because of a bearish stance, but to prevent allocations from drifting higher as stock markets outperformed other assets.
“We weren’t taking a strong view against equities, but we were just saying we weren’t happy with the weight drifting up over time as equities were overperforming other assets,” she noted.
NEST also takes advantage of short-term volatility to rebalance its portfolios.
“We think at the margin, by smartly rebalancing, we can make some nice incremental returns for members. We’ve been taking a long-term view and then using short-term market volatility to enhance those member returns,” Fernando continued.
Looking ahead, she stressed that diversification remains central to NEST’s investment approach, with portfolios built to be resilient across a wide range of possible economic scenarios.
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