NEST picks its managers
We sent out a press release in November 2010 (after NEST Corporation announced its decision to adopt a target-date fund approach to the default option widely expected to dominate members’ selection choices) challenging NEST to be more forthcoming about how they planned to manage the default fund. Whilst a liability-driven approach has much to commend it (it’s how we manage money), we wanted to see how they planned to ensure that the ‘purchasing power’ nature of the liabilities, not just their duration, was well matched. Otherwise, the risk reducing strategies used in the target date funds for different retirement dates would not reduce risk, merely swap inflation risk (which is not rewarded) for equity risk (which is).
Now that NEST have announced (3rd February) the five fund selections that the Committee and Trustees will use as building blocks in the default target-date funds, the questions we asked appear even more important. There is much that is experimental about auto-enrolled pensions without making the investment solution another laboratory experiment.
Passive bond manager: State Street
NEST has appointed a manager for each of conventional and index linked gilts (State Street in each case) but we are left still guessing which in NEST’s view best matches the liability or how they will use fixed-duration passive funds to meet different duration target date funds.
Passive equity manager: UBS
In all likelihood the largest position across all the target dates collectively will be equities. The UBS global equity fund is therefore the key pick. It is what I think is called ‘a brave choice’. At NEST’s request, this new passively-managed fund has no bias to the UK as ‘home market’, so the UK proportion of the equity exposure is whatever it represents in the FTSE World Index of developed markets. An unbiased global approach is possibly optimal in the lab but is asking for trouble given the real world investors (and committees) inhabit. The first rule of any strategy is that it must be one that can be lived with. This is likely to be ditched by future trustees the first time UK equities substantially outperform most foreign markets, or a large foreign market underperforms most markets, including the UK, as is bound to happen at some point.
Active multi-asset class manager: Blackrock
With those core building blocks in place, the next curiosity is why NEST wanted a role for the Blackrock Market Advantage strategy. There is a certain logic in adding ‘alternative’ asset exposures but the strategy agreed with Blackrock mainly adds more conventional bond and equity ‘market beta’ exposures to those provided by UBS and State Street and throws in a small dose (Blackrock say 10-20%) of alternative beta exposures like property and commodities. The exposures are all via passive vehicles but the allocations between them will be managed actively. How they will be managed is interesting.
This has grown out of a fund that had to go back into the lab for some re-engineering after suffering a 46% peak to trough decline in the bear market of 2008/9. That makes it look like another brave choice. NEST’s version will not be geared, unlike the fund it is based on, but the main change coming out of the lab is the addition of proprietary rules based on short-term signals, to smooth the return path. In the backtests NEST were shown, the bear market barely made a dent in the simulated return path. But that’s what backtests of market timing rules do. Maybe the right lesson for NEST to have learned from the earlier version of this fund is that market risk cannot be transformed by clever engineering.
It is not at all obvious why this strategy will improve on the efficiency of the conventional building blocks provided by UBS and State Street let alone meet NEST’s claim it can provide the same return as a 60:40 global equity:bond mix with 40% less risk. That is a very tall order in the real world. In fact, it is the sort of claim regulated retail firms think twice about making nowadays, with the FSA handing out £7m fines for poorly describing product risks.
Last time we put out our press release NEST told us we could not possibly know how they were going to manage the default funds and should keep quiet until they had worked that out. I am not unsympathetic to their position. Rarely is anyone’s investment policy so publicly scrutinised and no one policy will ever command every one’s respect. I write about it because we have to struggle with similar decisions and I find it hard not to judge them as harshly as we judge ourselves.