The National Employment Savings Trust, NEST, the UK government-backed pension scheme set up a year ago with the introduction of auto-enrolment, developed a new allocation to real estate this summer. Now it is planning to add infrastructure to its illiquid allocations in a move reflective of a change of thinking to embrace more risk. NEST’s infrastructure foray is most likely to be via a blended infrastructure fund investing in both listed and direct infrastructure, explained chief investment officer Mark Fawcett at a recent National Association of Pension Funds (NAPF) investment strategies conference in London, where he urged defined contribution schemes to “break the mould” and push greater diversification. “We might add other illiquid assets and we are looking at infrastructure,” says Fawcett, who joined NEST from boutique investment manager Thames River Management. “There are good parallels between infrastructure and real estate. We are looking for growth-seeking and income-generating assets.”
With £11 million ($17.6 million) under management so far, NEST’s assets are forecast to reach $240 billion by 2050. Allocations in the Growth phase portfolio are divided between equities (50 per cent), real estate (20 per cent) and fixed income (30 per cent), where the portfolio includes corporate bonds and emerging market debt. Although NEST has been in talks with the NAPF’s Pension Infrastructure Platform (PIP), which says it is keen to have defined contribution investors, its need for continuous cash flow and the challenge of infrastructure being “lumpier than real estate and the cash flow varying” makes a blended fund a more likely model. The challenge is to now find the right low-cost manager, says Fawcett. “We are not in the business of paying 2 and 20.”
The property push
The push into infrastructure follows on from NEST’s 20 per cent real estate in the Growth phase allocation made last July. “It did raise eyebrows because it is a high allocation for a defined contribution fund, but it makes sense,” says Fawcett, adding that in Australia the allocation would “be double”. It’s an exposure that comes via Legal and General Property’s Hybrid Property fund in another blended strategy gaining exposure to listed and unlisted property. Here the hybrid structure comprises a 70-per-cent weighting to a UK direct property fund, with the remainder weighted to passively managed listed real estate via a global real estate investment trust (REIT) tracker fund. The addition of the global listed fund enables access in a daily priced, daily dealt manner with a greater amount of liquidity. The management charges are lower, the spread is reduced and there is international diversification, explains Fawcett. “We chose the hybrid because it is cash-flow positive and we thought direct real estate could be lumpy. We will think about a global direct allocation over time. We are aware of the leverage in REITs and that the shares are more volatile because of that leverage.”
Regulation and the members’ market
One of the biggest hurdles facing the pension provider’s new illiquid allocation is the daily dealing and pricing requirements placed on defined contribution schemes – that not the norm in defined benefit funds. These tend to rule out any type of unlisted property fund. One answer has come via NEST’s own internal market and its ability to trade illiquid assets between its own members, with older members selling assets to younger ones able to take on more liquidity. “We are doing this with real estate and are thinking about how to do it with infrastructure to ensure fair transfer between different members,” says Fawcett. NEST is currently working with another pension fund that has set up an everyday proxy to measure the price for infrastructure assets using an index which tracks the daily price movement.
Phase-sensitive allocations
Investment strategy at NEST, where Fawcett says the emphasis is “to get away from the peer group comparisons”, is honed for three distinct periods. For young savers in the Foundation phase, strategy is low risk, aiming for returns that match inflation and encourage saving. The Growth phase, typically lasting 30 years, targets returns of inflation plus 3 per cent in a diversified strategy. The final Consolidation phase invests in inflation-matching assets to de-risk. It seems that in the Growth phase, real inflation-linked assets are increasingly attractive over gilts and bonds. “Big defined contribution schemes should expand into other asset classes,” says Fawcett. “Defined contribution has not got to grips with what real estate has to offer.”
