As NEST looks to recruit fund managers for a range of mandates, the Financial Times' David Stevenson asks if they have got their asset allocation model right.
Innovative new national pension scheme called NEST seeks attentive, well established fund managers willing to work hard for a small amount of money but lots of prestige. Active fund managers need not apply unless they have specialist skills....
Sadly the adverts running this week for NEST - seeking best of breed multi-asset class managers for the new national pension scheme - are unlikely to feature such ripe language.
Instead the official procurement notices are likely to emphasise the need to understand risk control and have a willingness to implement passive strategies at an industrial level. But be under no illusions that the recruitment drive for industry expertise is potentially revolutionary.
At this first stage of a longer process of recruiting managers NEST will be looking for expertise in five broad categories namely: global equities, conventional and index-linked gilts, managed cash and diversified global growth (perhaps more accurately summed as up as global alternative beta). But the job spec for the first three categories carries a clear and rather blunt message - only passive fund managers need apply. So that's most of the industry out of the running straight away. Yet even the last two categories still carry a presumption in favour of passives.
According to NEST's chief investment officer Mark Fawcett the global alternative beta category will still have underlying elements that are passive but some active overlay (of a non-tactical variety). As for managed cash, this category might as well be equivalent to cash given the likely incredibly low expense ratios on offer! This presumption in favour of passive is of course in part based on costs - with NEST charging only 30 basis points overall in annual fees (plus that slightly controversial initial charge!) its hard to see how it could entertain any mainstream asset class fund manager - passive or otherwise - charging much more than 10 basis points in total expenses on their fund.
Maybe the Global Beta category overall might stretch to say 30 basis points - its likely to be a smaller part of the wider, cheaper portfolio - and no doubt the active bits of this category might stretch to say 40 basis points. But this portfolio has to be cheap and I struggle to see how any clever, alternatives based boutique could ever deliver a fund to NEST at these rates. As for hedge funds - they need not apply !
Yet it would be wrong to assume that this emphasis on low cost passive is only about costs. Talking to Fawcett it is clear there is an academic bias against active with Mark and his team clearly doubting whether active fund managers can add value in mainstream, efficient markets. I'd like to say that his views are mainstream but we all know they are not. Most mainstream pension funds and endowments still subscribe to the myth of active fund management with anything between 50% and 75% of assets under management steered away from passive. NEST's bold statement will act as a catalyst at many trustee meetings - "so tell me Mr Consultant, why exactly are we using more expensive active fund managers in our pension when NEST is doing the exact opposite"?
But this bias in favour of passive isn't the only ground breaking aspect of this announcement. Notice, I haven't mentioned the words UK Equities yet. The global bias has already been carefully trailed in its announcements already but NEST obviously sees no need for an explicit UK mandate - as Fawcett quite rightly maintains most of the schemes members (likely to have lower than average incomes) are already heavily exposed to the UK anyway, so why double up on that exposure.
I suspect most pension fund managers in the mainstream have already woken up to this issue but IFAs are woefully unprepared. Most advisers I talk to still weight their clients portfolios aggressively towards actively-managed UK equity funds. If NEST is right, this represents a massive mistake and a potential source of enormous litigation in coming years if the UK equity market underperforms. If NEST's mainstream UK equity exposure is say 10 to 20% how can any adviser recommend holding 50% or more in UK funds? Answers on the back of a SAE envelope please!
The last key idea is buried deep within a fairly complex statement of principles called Designing an investment approach for NEST. This document sets out many of the arguments that inform Fawcett and NEST's approach but one chart called Lifestyling Framework particularly caught my attention. This describes a fairly normal bell-shaped asset allocation approach to risk control - with one key difference. It suggests that younger investors - aged up to 27 - adopt a foundation portfolio which is largely cash and bonds. The thinking here is elegantly simple and very counterintuitive.
Conventional wisdom suggests that the very young are ideally suited to taking lots more risks! Yet Fawcett and NEST bring in behavioural analysis to turn this thinking on its head. They believe it is far more important that younger investors have a positive initial experience of investing and not be put off by starting their long term savings during a volatile bear market.
Losing a few hundred pounds early on may be easily recoverable over the long term but it tends to make younger investors frightened and discourages them from saving. If NEST's analysis is correct then the ideal age to take on risk is actually the mid to late thirties or even the forties. Is it time to radically transform those asset allocation models?
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