NEST reflects on 2024: Timber and thematic equities signpost growth

NEST, the United Kingdom’s fast-growing £45.3 billion defined contribution scheme, has warned that future returns will likely be more subdued than in the recent past. Speaking in a recent webinar, chief investment officer Liz Fernando questioned the likelihood of markets delivering extra returns over the next 5-10 years given they have seen a “phenomenal run” in recent years.

Valuations are high and interest rates are not coming down that fast because inflation remains sticky. She warned of the risk of disappointment, and cautioned against risk-on asset allocations. Meanwhile she said NEST will continue to invest for the long-term and try and ignore the short-term noise and volatility that will accompany the Trump presidency.

“Trying to make accurate predictions is a fool’s game. We learnt from his first presidency that he is erratic and doesn’t necessarily do what he says.”

Meanwhile, diversification will help safeguard NEST’s assets from bumps and volatility and the illiquidity premium from its growing allocation to private markets will boost returns. NEST targets returns at CPI+ 3 per cent and beneficiaries can choose different strategies (from five funds) based on how close they are to retirement, and their risk appetite.

Although NEST is comfortably ahead of its long-term return target, 3-5 year returns have been impacted by the spike in inflation. She said short-term returns are very strong.

Of all NEST’s five investment funds, the Sharia Fund has bagged the best returns because it is mostly invested in technology stocks and the wider equity boom given its strict exclusions. It has achieved a five-year annualised total return of 15.7 per cent compared to returns in the Higher Risk Fund of 7.5 per cent over the equivalent period.

“This has clearly been a fabulous place to invest in the last ten years,” she said. “This is the riskiest fund we offer our member.”

However, in line with her broader warning of lower returns ahead, she said the fund will now include a 30 per cent allocation to sukuk bonds that will have a market dampening effect on volatility.

“We believe anyone should be able to save for a pension, and not be excluded for [their] religion,” she said

Investing in the UK

Fernando estimated NEST will have invested around £20 billion in UK assets by the end of the decade, explaining this will grow from current levels of around £8.5 billion as NEST’s assets under management grow.

NEST’s investments in UK assets include property and infrastructure. A recent partnership with Legal & General and PGGM, which invests on behalf of Dutch pension scheme for healthcare workers PFZW, targeted £1 billion in build-to-rent schemes across the UK supporting the government’s target of delivering 1.5 million more homes.

“Through our investments we are able to get good returns and support the economic environment,” she said. NEST is about to begin publishing a quarterly summary of how it invests in the UK – just like it does with investment performance.

Referencing the growing pressure on pension funds to invest more at home from the UK government, she said that NEST only invests in members’ best financial interests.

“This is the primary lens through which we think. We will not make investments simply because we are encouraged to do so.”

Innovation

This year, innovation at the fund includes a new active, externally managed allocation to multi-thematic equities. The allocation (targeting £5 billion by 2030) focuses on developed markets and seeks to benefit from key themes influencing financial markets including natural capital.

NEST currently has around half its portfolio in listed equity funds aligned with a transition to net zero by 2050. The new allocation to thematic equities seeks to bring active investment into its climate and wider ESG ambitions.

Elsewhere, a new allocation to timberland counts as one of the most interesting and fast-evolving allocations in private markets. Launched a few months ago, investments already include forests in the US and Australia. A transaction is close to completion in New Zealand. NEST’s private markets allocations include real estate, added in 2012, private credit, added in 2019, infrastructure and renewables, added in 2021, and private equity which was included in 2022.

Fernando explained the benefits of being invested in an allocation that grows in value over time, mirroring the liability of members.

It is also possible for investors to harvest returns mid-cycle by thinning forests, and although timber fits comfortably into portfolios for beneficiaries at the early and mid-stage of their saving journey it offers valuable income and strong cash yields too. It also has the scale for NEST to maintain a consistent portfolio allocation, which is essential given the investor takes in £500 million net contributions on a monthly basis.

It also allows the investor to influence outcomes via engagement and stewardship, another key pillar to strategy that reflects its ambition to encourage real world change so that its members can retire into an attractive world

Driving hard bargains

NEST’s timber and thematic allocations saw fierce competition from asset managers – 12 managers applied to run the timberland mandate and 29 applied to run the thematic equities mandate. Fernando said the investor’s scale and growth give it an increasingly powerful negotiating advantage that ensures the best deal possible.

“We drive hard bargains with external managers so members benefit” rather than asset managers buying more “yachts and Ferraris.”