Nest’s new head of long-term investment strategy, Liz Fernando, explores some underappreciated asset classes that could prove fruitful for pension fund investors in the years ahead.
What is clear, even after just one month, is that we continue to face a similar landscape to last year, led by volatility and doubt about what is around the corner.
While the rollout of Covid-19 vaccines across the world is a welcome development, the ongoing pandemic and new virus strains are hindering the start of economic recovery.
Restrictions are unlikely to be fully lifted in the coming months, and one of the few certainties is that the pandemic is going to continue impacting all parts of our lives for a lot longer. Even once the pandemic is over, ‘normal’ will be different.
What has gone before does not look like it is still fit for purpose in the new world in which we find ourselves
This causes serious problems for investors, but it is our job to react and adapt.
Adapting to the new world
For the past decade, investors have experienced what was arguably the best bull run ever. Buoyant markets meant that a traditional 60:40 stocks and bonds portfolio generated strong returns. And, in the process, we have helped a lot of people prepare for a better retirement.
At Nest we believe the investment landscape has changed and investors now need to consider what more they can do to find attractive opportunities. As with any change, the whole industry needs to take stock and reconsider our approaches.
Developed market equities, which have been the driving force behind recent strong returns, are getting more crowded and expensive, limiting the future returns they bring our members. Central bank policies continue to suppress bond yields, and investors are not being suitably rewarded for the risks taken.
What has gone before does not look like it is still fit for purpose in the new world in which we find ourselves.
In my new role at Nest, I am considering ways to build upon our forward-looking capabilities and awareness of emerging risks and opportunities. That means ensuring we are reviewing our allocations and benefiting from long-term trends.
Just being invested is not enough to achieve the high targets we have set for our funds.
We believe some asset classes are being mis-analysed or overlooked, which often means they are potentially lucrative opportunities.
Emerging opportunities
Emerging market equities is a clear example of this. We saw many Asian economies effectively contain the virus and demonstrate strong economic resilience.
Unlike past crises, debt affordability remains good and currencies have been robust. We have even seen some emerging market central banks use quantitative easing for the first time, a policy tool until now reserved only for developed markets.
Lower volatility and more resilience are usually rewarded with higher valuations or lower discounts to peers.
Over the coming decades, large economies such as China and India are also expected to experience continued expansion of the middle class, presenting opportunities to companies that can profit from increased spending power and more demand for services we take for granted.
Another opportunity is investing in private markets, which are no longer automatically out of reach for defined contribution schemes. In fact, in the coming months we will be announcing the fund managers that will be helping move Nest into unlisted infrastructure equity. It is an exciting development.
One strength of long-term investors like pension schemes is that we can be patient with people’s savings and harvest an illiquidity premium. When chosen carefully, infrastructure projects can offer stable, long-term returns, even in difficult market conditions.
We also plan to specifically focus on increasing our investment in renewable infrastructure. These should be reliable sources of income for decades to come, with more countries supporting the transition away from carbon-based energy generation. Nest has committed to be a net-zero investor by 2050.
Adapting for the times
These asset classes may not have been on your radar but can play a significant role in your portfolio. By diversifying you give yourself options and new levers to pull on, reducing your reliance on specific asset classes that may no longer provide the right performance for the level of risk you are taking.
Accessing them does not have to be expensive and keeping costs under control is another important way to protect members in a low-return environment.
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Pension schemes are going to have to work harder to help their members boost their savings. Returning to the world pre-lockdown does not look to be on the cards, so we must adapt — we cannot expect to keep doing what was working for us before. Times have changed.
New sophisticated investment strategies, ones that spread investments across markets and economies, should give the best chance to keep hitting targets this year and well into the future.
Liz Fernando is head of long-term investment strategy at Nest
