Cover story – The markets in 2023
example, Nest’s 2040 Retirement Stage Default fund is down 7.6%, year-to-date, having reported an annualised total return of more than 7% over the past 10 years. Other growth-oriented DC default funds are also booking losses. Legal & General Investment Management’s Future World Multi-Asset Fund was down more than 11% as of September 2022. But Maria Nazarova-Doyle, head of pension investments at Scottish Widows, believes bonds remain an opportunity for DC schemes. “At Scottish Widows, we still believe in diversifying the nature of the fixed-income securities we hold across our portfolios, as we observe yields settling into a new range adapted to the new inflationary environment,” she says. “Indeed, for the first time in many years, we are reviewing opportunities to increase exposure to government bonds in our portfolio. If 2022 has taught us anything, it’s that ‘business as usual’ no longer holds.”
Currency risk and the deteriorating outlook for the UK economy are other themes that will dominate her strategy for the year ahead. As the dollar continues to rise, Scottish Widows is among the investors questioning whether there is a need to hedge currency risks of dollar-denominated assets. “We intend to maintain our structural hedge but are in the process of reviewing its size,” Nazarova-Doyle says. “More outwardly, we are also looking for opportunities to incorporate more global equities into our portfolio, mitigating against the effects of a UK market that will remain defensive for the foreseeable future,” she adds.
DC assets are on track to grow significantly during the next three years, hitting the €850bn (£739bn) mark by 2025, pre- dicts Cerulli Associates, a consultant. At the same time, the share of master trusts within the DC market is on track to dou- ble to 40%, up from 17% at the beginning of 2022. With this growth in scale comes increased opportunity to branch out from traditional DC strategies, which are heavily focussed on passive exposures, to developed market equities. One example is Nest allocating to private equity for the first time in 2022. It remains to be seen if other master trusts fol- low suit in 2023.
In addition, there is the government’s consultation on broad- ening investment opportunities for DC. Among the proposals is a move to improve transparency on illiquid assets. Scottish Widows has participated in the consultation and Nazarova-Doyle describes the steps as “encouraging”. While Scottish Widows’ DC funds are not exposed to infrastructure, she sees opportunities. “These types of investments can improve the overall risk/return profile of DC portfolios and can help increase returns through a illiquidity/complexity premium, while reducing volatility and providing inflation protection, particularly when it comes to infrastructure investments,” she adds.
22 | portfolio institutional | December-January 2023 | Issue 119 Insurance: Solvency II reviewed
The changing economic background is also a key theme for insurance investors. While the LDI crisis has been a challenge on an operational scale, many insurers have benefited from lower bond prices and so have seen the crisis as an opportunity.
This includes Phoenix, which stocked up on government and corporate debt in October. But chief investment officer Mike Eakins acknowledges the scale of the challenges facing inves- tors next year. “We are now in a new interest rate paradigm,” he says. “Twelve months ago, interest rates on 10-year bonds were below 1%, and now they are at 3.5% and that clearly reflects the inflationary environment we find ourselves in and the economic headwinds we face. This will dictate how insurers invest their money.” Eakins believes that the rise in bond yields will make private markets relatively less attractive. “If you invest in government bonds at 3.5%, then you don’t need to go and shoot the lot out on private markets. Private markets are still a material asset component but at the margin, you will see less demand for pri- vate markets.”
Rising inflation will result in higher pension costs, so generating income will be increasingly important in the coming years.
Mark Lyons, Border to Coast
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