Policy makers in the UK are suggesting pension funds invest more at home to support economic growth, but investment executives at the funds say it’s not that simple.
The UK’s defined benefit funds, many in their end game as corporates prepare to shift their liabilities off balance sheet, aren’t positioned to tie up assets in illiquid investments. Moreover, many are still feeling the impact of the largely government induced LDI crisis. Elsewhere defined contribution schemes like Nest, although fast growing and already investing in illiquid assets in the UK, still lack the size to invest for economic growth on the same scale as the Australian DC model.
Policy makers have recently suggested that pension funds should invest more at home to support economic growth. But investment staff at the UK’s pension funds say it’s not that simple.
Nest, the UK’s £30 billion flagship DC fund, growing at around £400 million a month due to contributions from one in three working Britons, is just the type of investor the UK government has in its sights to invest more at home to fuel growth. Speaking on the side-lines of the annual pension association conference as part of advisory firm LCP’s Investment Uncut podcast, Nest CIO Liz Fernando, sounded a warning bell against investors being told where to invest by geography or asset class.
She said Nest already invests some 45 per cent of its assets in the UK and would resist any government compulsion on how it invests – an approach, she warned, that “always ends badly.” She also flagged that it takes time for Nest to put capital to work in infrastructure, where scaling up has been a little slower than imagined although managers are right to be picky on price and terms.
Investment Uncut interviewee Cliff Speed, CIO of £10.3 billion TPT Retirement Solutions, reflected that pension funds looking to the future can’t ignore the lessons of last year’s gilt crisis when the market froze over and it was impossible to trade.
Speed said that the unprecedented volatility in gilts has seen investors build new risk models into their portfolios that incorporate much bigger moves in gilts prices. This in turn has implications for how much they are prepared to invest in illiquid assets, running counter to the government push. Reflecting on the crisis he also noted the importance of diversity of thought and the value of people who think differently – everyone thought last year’s sharp movement in gilts was impossible.
Still, Speed noted that although DB schemes are looking to have less illiquid assets, DC schemes are wanting to build up exposure. “Is there a trade there?” he asked, adding that the barriers for DC schemes to invest in illiquid assets are starting to come down coupled with an awareness amongst participants of the benefits of “slow finance” – aka investing for the long term.
Investing more in the UK for growing LGPS and DC funds may make sense, said John Chilman, CEO of Railpen who said research shows that illiquid investments in DC improves member outcomes. But he noted that Railpen, an open DB pension fund, already has significant UK holdings in infrastructure assets like windfarms and solar.
Investing more at home is also challenging when pension funds are worried about growth because of high inflation. For example, Fernando, who also had a 25-year stint at USS, said the fund targets CPI +3 per cent net of fees which in today’s high inflationary environment is a reach. Although higher interest rates have led to better nominal returns, most assets currently fail to meet Nest’s return target making a long-term view and diversification central to strategy.
She added that as inflation drops back, Nest will be able to deliver on its target return. Moreover, the fund now has the assets in its tool kit including private credit, infrastructure and renewables to diversify plus its huge monthly inflows help support a natural rebalancing.