Defined contribution – Feature
2022 was a difficult year for investors.
Mark Fawcett, Nest
charge cap, it also warns that this now puts the onus on trus- tees. “There’s nothing intrinsically wrong with performance fees provided there are sufficient protections for members built into investment management contracts. Exempting per- formance fees from the cap returns member protection responsibilities back to the trustee. It should not be forgotten that trustees have a legal duty to put the interests of savers above everything else,” a spokesperson for the master trust said. The combination of these potential reforms could accelerate a trend of DC schemes interacting more with asset managers, predicts Henry Tapper, executive chair of pensions consolida- tor Age Wage. But he also warns that assessing outcomes for DC members would require a much more customised approach and should not be based on the investment performance of defined benefit schemes. “Rather than measuring net perfor- mance on a top-down basis, we expect to see performance measured against time-weighted returns measured from the bottom up,” Tapper says. As the government takes a greater interest in the management and asset allocation of DC default funds, a risk to consider is that this could lead to a growing concentration in some seg- ments of the market.
Sharples warns of the danger of simply developing indices for investment strategy or asset allocation. “To what extent is there a basis for this asset allocation and is there a risk of this being arbitrary?” she asks. “Does that then become the norm? Equally, a default strategy might be right for one size of the population but not for other groups, so there are lot of subtle- ties and there won’t be a one-size-fits-all approach.”
Re-thinking growth portfolios
The sum of these factors mean that schemes are now consider- ing significant changes to their investment strategies. Aon is one of the master trusts which is considering investing
in alternative assets, Sharples says. “It is about thinking of the assets that will be the right fit at different stages in somebody’s lifetime.” So, for early stage default funds, private equity would probably be a reasonably good fit. “It also involves thinking about infla- tion and developing inflation protection where real assets such as infrastructure and property could play quite a nice role,” she adds. “These investments also have potentially quite a strong ESG impact.” Nest committed £3bn across two private equity mandates last year and is considering other strategic changes. This includes increased exposure to investment-grade bonds, at the extent of high-yield paper, in an attempt to minimise the risks of poten- tial credit losses, Fawcett says.
The master trust has also upgraded the outlook for global real estate investment trusts (REITs), predicting that property prices may not fall as much as expected. In exchange, it pre- dicts that the surge in commodity prices will slow down as European economies show signs of recovery and supply short- ages are starting to ease.
Re-thinking decumulation portfolios But the changes do not stop there. Last year’s bond market troubles have forced investors to re-think their decumulation portfolios, Sharples says. The Aon Mastertrust has been fortu- nate to have reduced its exposure to long-dated gilts going into 2022. “We have made quite a lot of changes since the end of 2021, thinking about the fact that inflation and interest rates were going to rise,” Sharples says. “This means we have invested quite a lot in shorter maturity bonds and loans which are not commonly used by DC schemes. We had to think about other assets out there and that worked well last year.” The People’s Pension has also reviewed its fixed income expo- sure. “Global economic instability, largely caused by the war in Ukraine and the continuing fallout from the pandemic, meant 2022 was a challenging year for investment performance across the board, and we weren’t immune from this,” a spokes- person said.
“During 2022, the main change we made to our asset alloca- tion was reducing the duration and increase diversification of our bond portfolio by selling gilts and sterling corporate bonds and purchasing US treasuries. The gilts and sterling corporate bonds were reduced from 5% to 3% of the portfolio while the US treasury exposure is 4%.”
Overall, the past year has been perhaps the most challenging but also most interesting for the rapidly evolving defined con- tribution market. While the market is still in its early stages, the changes made now, in terms of policy measures and asset allocation decisions, could potentially shape the UK’s invest- ment landscape in the years to come.
Issue 121 | March 2023 | portfolio institutional | 23
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