London-based National Employment Savings Trust (Nest) is the UK’s default auto-enrolment pensions scheme. With 7 million members, it manages money on behalf of individuals with relatively small pension pots.

The UK government had required that ‘auto enrolment’ schemes must be introduced from October 2012 by companies with 250 or more employees, as it felt that too few workers were contributing to retirement funds.

Nest is young, but set to grow very fast. The fund started from effectively zero in 2012 to reach £3.5 billion ($4.5 billion) as of August this year, and could potentially hit £12 billion in 2020 on the back of rising contribution rates.

John St Hill

AsianInvestor spoke to John St Hill, deputy chief investment officer of Nest, about how the scheme is run and how it allocates.

Q  AsianInvestor: Presumably you mainly use external asset managers now? Do you expect to build the investment team as you scale up?

A  John St Hill: Currently we don’t do any trading in-house; our whole process is run by third-party managers, with the asset allocation overseen by our in-house team.

[As we grow,] we’ll add managers and new asset classes. One of the more interesting things we did last year was to add high-yield bonds and a climate-aware fund to our target-date funds. And we added our first commodities manager this year.

Over 99% of members coming into Nest go into one of the default [target-date] funds, and within those default funds, the allocation is optimised to make it suitable for the people retiring in that particular year. So we offer a 2040 default fund, a 2060 default fund, etcetera, and the allocation changes as members get closer to the fund’s maturity.

Q  Do you use pooled funds or segregated mandates or a combination?

A  We invest entirely through commingled funds and segregated mandates currently. Most of what we do now is in pooled funds, but I would envisage us using segregated mandates more as we get bigger and need greater levels of customisation.

Q  What’s your allocation breakdown?

A   Around 60% of the allocation for all the default funds is in equities, and it’s internationally diversified, with around 90% of the equity portfolio invested overseas. That fits with our investment belief that diversification is one of the key ways to improve returns and reduce risk for domestic investors.

We have equities, debt – including high yield, UK corporate bonds and some short-dated gilt portfolios – property and commodities.

Q  What sort of allocation do you have to emerging markets?

A  We’ve currently got an overall allocation to EM of around 10%, with around 5% in debt and 5% in equity [as per the fund’s reference portfolio]. This may well rise over time, but we don’t have a view at the moment of how much.

We access emerging markets via global mandates at present. It may be some time before we would drill down further into, say, Asia equity mandates.

Q  You added commodities to your portfolio in July; are you planning any other changes to your allocation?

A  We run a research programme to identify new asset classes we think will improve the risk-adjusted returns. We’re currently looking at global corporate bonds and infrastructure debt and at private markets generally and the ways we can get an illiquidity premium into the portfolio.

These programmes tend to run for 12-18 months, and we haven’t launched a tender [for those asset classes] yet.

Q  What’s your view on active versus passive strategies?

A  Passive investments represent about 50% of our total allocation. We think that, where available, index management can be more efficient than active management. Our climate-aware fund is a smart-beta [equity] implementation.

However, there are asset classes where index management is likely to be inherently challenged. With bonds, for example, it makes sense to use active managers because you can avoid some of the more indebted issuers and you can address issues around illiquidity of certain bonds, which don’t trade regularly.

So for the moment we’re still more likely to use active managers in the corporate bond space.

This is an extract from an article that will appear in full in the forthcoming August/September issue of AsianInvestor magazine.

Click on the links in this sentence for more on how Nest and other UK pension schemes are employing ESG concepts, factor-based equity strategies and private debt in their allocations, and on what else such funds can pass onto Asian retirement plans.