Cover story – Defined contribution
exposed to the asset class, including a tilt towards climate- aware companies. As a result, the six largest US tech stocks account for 13.7% of the equity portfolio. Similarly, The People’s Pension, which manages £17bn in assets, is alongside LGIM as the UK’s second largest master trust and has 58% of its default fund invested in developed market stocks, with US tech giants featuring heavily. Lifesight, Willis Towers Watson’s £13bn master trust, has 70% of its default portfolio in equities, which includes exposure to emerging market stocks. Standard Life, Aegon and Fidelity, the other big players in the market, are 64%, 80% and 75%, respectively, invested in devel- oped nation stocks. The £17bn LGIM Master Trust, stands out by having only around 40% of its 2040 default fund invested in equities, with a higher allocation to direct property, real estate investment trusts (REITs) and inflation-linked bonds. Similarly, Mercer’s Master Trust has just north of 40% of its assets in equities, with a higher exposure to emerging markets, high-yield debt and listed property. But overall, DC master trusts tend to be heavily concentrated in developed markets and because of the market cap weighting of US indices, there is a heavy focus on tech. There is something to be said for this strategy. By the end of 2021, Nest’s 2040 Fund returned 14.3% and more than 9% since its launch, outperforming the benchmark by more than 4%. No doubt if it had stayed clear of tech stocks, it would have underperformed. The People’s Pension’s 85% shares fund has also performed a respectable 14% during the past year, beating its benchmark. Across the board, DC master trust default funds have achieved a relatively strong performance, given the investment constraints they are facing.
All good things must come to an end Yet the investment environment is changing, and DC mem- bers will have to react. With US inflation at 7.5% and the cost of goods and services in the UK climbing to 5.5%, multiple cen- tral bank rate hikes are on the cards. In return, developed mar- ket equity indices have dropped. The S&P500 has fallen 6.7% in the year-to-date and the Dow Jones by some 4.5%. Data from option trades suggest that the S&P500 could fall by between 16% and 21% by April, Bloomberg reports.
Investors are not yet in agreement on the long-term outlook for developed market stocks, but most admit that the double-digit returns earned over the past decade may be a trend that is end- ing. So, what does this mean for the asset allocation of DC default funds? Are they able to diversify, given the investment challenges they are facing? Marc Bautista, senior director, investments at Willis Towers Watson argues that inflation might not be as much of a long-
24 | portfolio institutional | March 2022 | issue 111
Right now, there seems to be a focus on cost, rather than
value. Marc Bautista, Willis Towers Watson
term factor as feared, but uncertainty has increased. “Our base case is that inflation will remain high this year then fall back to more normal levels,” he adds. “We are looking deeply at a range of factors that are causing that inflation and considering which are transitory and which are persistent. Then we look at how we expect those factors to play out in the medium term. “We also recognise that there is a range of potential outcomes around that outlook,” Bautista adds. “For the first time in many years, there is genuinely a feasible possibility of high inflation and disinflation.”
The team has attempted to diversify the portfolio by investing in a combination of alternatives, higher yielding fixed income strategies, property and infrastructure. He is sceptical that listed property and REITs offer sufficient diversification from equity indices. “We didn’t just want to invest in pure passive REITs or infrastructure securities because the correlation with equities is too high,” Bautista says. “We didn’t think they were truly diversifying. So, instead, we worked with a special infrastructure and property manager and asked them to construct something akin to an index which cov- ers a subset of the infrastructure and property universe respectively.” Nest, as the biggest player in the market, has been at the fore- front of master trusts branching out into more illiquid assets. It aims to invest some 5% of its portfolio in infrastructure by the end of the decade and has also issued a tender for a private equity strategy. Its 2040 Fund includes 3.3% of the portfolio in listed property, 4.5% in hybrid property and 1.8% in infrastructure. For Bautista, it is important investors remain flexible to adjust their strategies if the market changes. “We keep refreshing our look at those indicators and try to construct portfolios that are relatively robust to whatever happens,” he adds. “Our alloca- tions to sectors such as fallen angels, global high yield and
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56
