Defined Contribution Under the Microscope

Defined Contribution Under the Micros ope In conjunction with

“DC's time has come: The UK has 10 million active members and approaching £500bn AUM"

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Defined Contribution Name ofUnder issue here the Microscope | Spotlight

Engagement with ESG

Contents

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Focus on ESG P18

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Baillie Gifford: Impact investing P24

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Guest View: Cushon P26

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Guest View: Quietroom P28

Private Markets

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Introduction P5

➡ Focus on Private Markets P30

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Appendix P42

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Schroders: Private markets P36

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Fulcrum: The LTAF Revolution P38

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Guest View: Smart Pension P40

Modern Default Design

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Focus on: Default Funds P6

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AllianceBernstein: Default strategies P12

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Ninety One: Crunch time for Credit P14

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Guest View: Barnett Waddingham P16

Focus on Modern Default Design

Defined Contribution Under the Microscope

Focus on Private Markets

Focus on Engagement with ESG

3

Welcome

T

he wheel has turned: As Defined Benefit (DB) arrangements run off and the Baby Boomer generation retires, existing and future generations, especially those in the private sector, will almost certainly be in Defined Contribution (DC) arrangements. In fact, research suggests the UK already has 10 million active members and invested assets are approaching £500bn. This is set to double in the next couple of decades. DC members have long been considered the poor relation in pension provision. Today, are these savers being given sufficient attention? Are their investment solutions fit for purpose? And will they feel inspired to save for their retirement? the Virtual Panel and industry think-tank the Defined Contribution Investment Forum (DCIF) joined forces to put these issues – and more – under the microscope. Three webinars were held in July ’22 with leading DC experts across asset managers, consultants and master trusts. In this publication we have written articles which cover the key points discussed in the three webinars: Modern Default Design, Engaging Members with Impact and ESG Leadership and Private Markets for DC. Please plunge in for a deeper dive…the videos are embedded for your viewing pleasure!

Our Publication Team

Louise Farrand is the Executive Director of the DCIF, and a freelance journalist Matt Johnston is the Founder and CEO of the Virtual Panel, and an independent investment advisor Erica Weathers is a freelance editorial designer and art director based in London

We have also curated some thought provoking articles from our participants. A huge thanks to all who took part. We hope you enjoy it! Let us know what you think!

Defined Contribution Under the Microscope

In conjunction with

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Focus rn on Mode Default Design

How DC schemes can build a modern default investment strategy By stepping back to consider their scheme’s D objectives, DC decision-makers will find the best way forward ➡ 6

Watch the round table recording

efined contribution (DC) pension schemes have changed immensely in recent decades and taken on a vital role. A panel of seasoned DC industry experts gathered from the investment, consultancy and research worlds to discuss the challenges facing DC savers and schemes, in a series of presentations which was followed by a panel discussion. DC schemes have become the main savings vehicle for retirement. These schemes must look after a hugely diverse community of workers: high and low earners, homeowners and renters, the financially sophisticated and those with less financial literacy. Most will be automatically enrolled into a pension scheme at the start of their careers, which will demand nothing by way of engagement. But when they retire,

Defined Contribution Under the Microscope

Click the Image to watch the webinar Top row: Matt Johnston, Jeff Boswell, Sonia Kataora Bottom row: Daniela Silcock, David Hutchins

Take Aways

1

DC schemes have become the main savings vehicle for generations of savers. With that comes a range of behavioural, regulatory and macroeconomic challenges. Focusing on DC investment design has never been more important, the panel agreed.

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AB’s David Hutchins laid out a set of principles that DC pension schemes should take into account when designing modern default funds. It is vital that schemes work with their investment managers to construct robust and flexible defaults, with clear objectives, supported by carefully considered scheme-specific investment risk and performance metrics.

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2022’s volatile fixed income markets show the vital importance of flexibility, said Ninety One’s Jeff Boswell. DC investors should look to multi-asset credit for the best chance of achieving attractive risk adjusted returns.

Defined Contribution Under the Microscope

people will need to make some complex financial decisions – or place their trust in default retirement pathways. Several obstacles stand in their way. When savers reach retirement, the siren call of the retail investment world can prove irresistible. In many cases, the over-55s are choosing to transfer their money into retail solutions. This can have serious consequences. “Our research has shown that individuals could lose up to 10 years’ worth of pension contributions simply by switching away from their occupational DC scheme into a more costly retail solution,” said panellist Sonia Kataora, partner and head of DC Investment at consultancy Barnett Waddingham. All these issues will have an impact on scheme design. Schemes have needed to adjust the structure

The Panel

David Hutchins is a Senior Vice President and head of AB's Multi -Asset Solutions business in EMEA Jeff Boswell is responsible for managing and leading the Alternative Credit investment team at Ninety One Sonia Kataora is a partner and Head of DC Investment at Barnett Waddingham Daniela Silcock is Head of Policy Research at the Pensions Policy Institute Matt Johnston is the founder and CEO of the Virtual Panel. He moderated the event.

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DC investment strategy design has become a strange and perilous adventure

of their funds to allow for freedom different populations within the and choice. At the same time, the same company. flexibilities have introduced a great deal of uncertainty: without the A strategy must be responsive to focus of a retirement date, it is change, whether it’s market difficult for schemes to know when volatility or regulatory changes like to start de-risking people’s Freedom and Choice. Ask your investments. People’s plans will investment managers how they are vary, and that will impact how and set up to respond to crises like when they want to use their pension Russia’s invasion of the Ukraine. savings. How did they respond to the The DC pensions industry has introduction of Freedom and also needed to adapt to other Choice? changes, which are designed to improve savers’ retirement Focus on value for money. For too outcomes. ESG has taken on a much long, the pensions industry has more important role, and schemes strategy design has become a focused on cost, at the expense of and their investment managers strange and perilous adventure,” all other considerations. It is time to have needed to keep up with a observed panellist Daniela Silcock, shift focus from cost to value for continuous flow of new regulation. head of policy research at the money, when designing DC default The government is also seeking to Pensions Policy Institute (PPI). investment strategies. remove barriers to investing in private markets and illiquid Principles to bear in mind when Consider how to measure investments. building a modern default performance. Schemes should The Covid-19 pandemic was a investment strategy document their investment further challenge, as schemes and In his presentation, AB’s David objectives, making sure they are the wider industry had to pivot Hutchins set out some principles clear, measurable and investable. overnight along with the rest of the for pension schemes to bear in Hutchins explained: “AB has world. As we emerge from the mind when they are building their developed a simplified benchmark pandemic, macroeconomic modern default investment against which we manage all of our uncertainty, geopolitical volatility strategy. strategies to make sure they are and rising inflation are further delivering good value for money in stress tests for everyone involved What is the scheme trying to the short term, whilst remaining in pension saving. Asset managers achieve? Before the scheme sets its focused on our long-term have had to respond nimbly to default strategy, it is a good idea to outcomes.” changing global events, workers ask some fundamental questions. may be revisiting what they can Inform your conversation with data Embed sustainable investing in the afford to save for retirement, and about your scheme’s specific strategy. Gone are the days when a pension schemes are on the front membership demographic. As we five or 10 percent allocation to an line, seeking to reassure scheme have already explored, these ESG fund was acceptable. Modern members. demographics will look very default DC investment strategies What Features a Modern Default Strategy Have? “All of these changesMust mean that, different from company to incorporate ESG considerations to some degree, DC investment company – and there will often be and approaches across the board. Managed as a single investment strategy What features must a modern default strategy have?

Robust Objective Setting

Flexible Implementation

Transparent Reporting

• Informed: client’s specific membership demographics and evolving DC needs

• Unconstrained: Able to support all asset class exposures and investment beliefs

• Demonstrate value-for-money: Member realised outcome net of all fees and costs

• Integrated: client’s beliefs on asset classes, ESG and value for money

• Adaptable: To support changing member needs such as drawdown

• Documented: Clear, measurable and investible objectives

• Efficient: Timely and cost efficient to evolve through time and report on

• Holistic: Full look through to support risk management and ESG reporting at plan and member level

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Defined Contribution Under the Microscope

Flexible DC Solutions Better Outcomes for Trustees, Employers and Members

Developing solutions which are flexible enough to adapt and respond to the uncertainties in the market, evolving regulation, and the unpredictability of each member’s savings journey, requires an approach with flexibility at its core. Meeting the needs of today’s members means supporting them with affordable investment solutions that will provide for their future and bridge the transition from full-time employment to life after work. Our suite of flexible DC solutions offer pension schemes the ability to help meet these needs for a wide range of members saving towards retirement and beyond. They are proactively managed to minimize the governance burden for trustees and employers and are exceptionally simple to implement.

Flexibility from Beginning to End.

alliancebernstein.com/go/ukdc This is a marketing communication. For investment professional use only. Not for inspection by, distribution or quotation to, the general public. The value of an investment can go down as well as up and investors may not get back the full amount they invested. Capital is at risk. This information is issued by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA. Registered in England, No. 2551144. Authorised and regulated in the UK by the Financial Conduct Authority (FCA – Reference Number 147956). The [A/B] logo is a registered service mark of AllianceBernstein and AllianceBernstein® is a registered service mark used by permission of the owner, AllianceBernstein L.P. © 2022 AllianceBernstein L.P.

Why a flexible approach makes sense

US High Yield

2009 2010

2011

2012

2013

58.1% 15.1%

4.4% 15.5% 7.4%

2014 2015

2016

2017

2018

2019 2020 2021

2.5% -4.6% 17.5% 7.5% -2.3% 14.4%

6.1%

5.4%

European High Yield 79.8% 15.7% -2.6% 28.6% 10.3% 5.4%

1.6%

9.3%

6.9% -3.3% 11.5%

2.9%

3.4%

EM Corps

39.1% 12.4%

4.1%

1.1%

9.6%

6.9%

7.1%

-1.4%

US IG

19.8% 9.5%

7.5% 10.4% -1.5%

7.5% -0.6% 6.0%

6.5% -2.2% 14.2% 9.8% -1.0%

European IG

14.9% 4.8%

2.0% 13.0% 2.4%

8.3% -0.4% 4.8%

2.4%

Global Hybrids

31.2% 12.7% 3.8% 15.3% 6.4%

7.8%

-1.7%

8.5% 10.3% -3.9% 12.7% 2.7%

5.2%

Short Duration HY

44.3% 12.0% 2.7%

6.5%

0.9%

1.2%

14.0% 5.3%

0.6%

8.7%

5.0%

6.3%

FRN

60.0% 12.6% -9.2% 22.3% 7.7%

3.7%

4.0%

5.0%

-1.8%

7.1%

1.8%

1.8%

5.8%

6.9%

7.3% 14.4% -3.7% 17.6% 6.8% -3.3%

7.3%

11.5% 12.7% 12.5% 4.4%

Bank Capital Differential (best/worst)

-

-

-

15.7% -0.9% 3.6%

13.1%

-

-

64.9% 10.9% 16.7% 18.3% 11.7%

1.9%

-1.3% 12.4%

-1.1%

6.3%

11.3%

2.6% -1.0%

8.0%

9.6%

A mixed picture: returns fromindicator each fixed income Past performance is not a reliable of future results,asset losses class may be made.

Source: Bloomberg, 31 December 2021. Europe IG: The BofA Merrill Lynch Euro Corporate Index; US IG: The BofA Merrill Lynch US Corporate & Yankees Index; Europe HY: The BofA Merrill Lynch European Currency High Yield 3% Constrained Index; US HY: The BofA Merrill Lynch US High Yield overarching Constrained Index; Short Duration HY: The BofA Merrill Lynch 1-3 year Global High clearly Yield Non-Financial 2% Constrained Index;their Floating Rate Notes: The BofA Merrill Lynch Euro Floating Rate Be adaptable. While date performance, it has With extensive resources, High Yield Index; EM Credit: The BofA Merrill Lynch Emerging Markets Corporate Plus Index; Bank Capital: Bloomberg Barclays Contingent Capital Global Index; Global Hybrids: The BofA Merrill Lynch Global Hybrid Corporate Index. All returns in local currency. For further informationbeen on indicesaand investment process, please see the important informationactive section. managers are well placed Confidential principles may remain consistent, very challenging period. to | Ninety One

the specifics may change. For instance, the initial methodology for the portfolio's transition to Net Zero alignment that was set two years ago may well be different to the one that we might be using in two years’ time, said Hutchins. Investing in fixed income: a fastchanging landscape The importance of responsiveness to change has been borne out in the fixed income world in recent months. The landscape for fixed income DC investors has changed significantly in recent months, explained presenter Jeff Boswell, of investment manager Ninety One. In early 2022, the challenge was seeking return in a low yield environment. In the summer of 2022, it is a question of finding opportunities in the midst of a significant repricing in credit markets. Schemes and their managers must also seek to mitigate the risks associated with rising interest rates and inflation. Looking at fixed income’s year to

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With more inflation likely and interest rates rising, where in the credit markets should DC investors be looking? DC investors may be best off taking a Multi Asset Credit (MAC) approach, suggested Boswell. Why? The chart above shows the returns of each individual fixed income asset class. The colour grading is from dark green to red, in terms of best performing to worst performing. The chart illustrates how much performance can change. To capture the many opportunities within fixed income, credit investors must diversify their sources of return.

DC investors may be best off taking a Multi Asset Credit approach

monitor the ever-evolving opportunity set and take a flexible and nimble approach. “Within fixed income, there are incremental asset classes which have quite distinct behavioural risk/return characteristics,” explained Boswell. “The way we think about it is that all these different asset classes effectively give us levers to manage the fund through different environments, whether that’s from a return-seeking perspective or a defensive one.” Using these different levers will help MAC managers to achieve an attractive return profile with more stability, even in periods of volatility and uncertainty, explained Boswell. Together, the session’s speakers highlighted the plethora of challenges involved in DC investing today. When scheme decisionmakers take a dynamic approach – underpinned by scheme-specific information and carefully considered principles – their default funds will stay current, whatever happens next.

Defined Contribution Under the Microscope

Advertorial

Designing a Modern Default Strategy

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Read More about AllianceBernstein

For investment professionals only.The value of an investment can go down as well as up and investors may not get back the full amount they invested. Capital is at risk. Past performance does not guarantee future results. Some of the principal risks of investing in AB’s TDFs include Market Risk, Interest-Rate Risk, Credit Risk, Allocation Risk, Foreign Risk, Currency Risk and Reinsurance Risk. AB’s TDFs are available as a default investment funds through UK registered pension savings schemes and seek to meet the requirements of a broad range of persons. They do not take into account an individual’s personal circumstances and may not be suitable for a particular individual or group of individuals with complex financial or personal circumstances. The views and opinions expressed here are based on our internal forecasts and may change at any time after the date of this publication. It is for informational purposes only and does not constitute investment advice or an invitation to purchase any security or other investment. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This is not an advertisement and is not intended for public use or additional distribution. This information is provided by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA, a company registered in England under company number 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA – Reference Number 147956). ICN2022684

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T

he investment solutions that support defined contribution (DC) pension schemes are becoming increasingly sophisticated—but DC members need solutions that are easy to understand and simple to use. It takes a proven approach, which starts with the desired outcomes, to meet this challenge. Starting with the End in View We believe that a modern default investment strategy should have three key features: robust objective setting, flexible implementation and transparent reporting. An effective default must meet the needs of its members. So, it’s critical to establish plan-specific risk and return targets, informed by regular analysis of membership demographics and the evolving needs of DC members as regulation and markets change. These objectives should integrate the governing bodies’ investment beliefs on asset classes as well as ESG considerations and value for money. Finally, the objectives should be documented in a clear, measurable and investible manner. Market conditions and member needs are continuously evolving. A modern default must be sufficiently flexible to adapt to change and capable and versatile enough to fulfil multiple functions. For instance, it must be unconstrained to efficiently integrate a range of asset-class exposures, including illiquid assets and bespoke ESG beliefs. A default should also be adaptable, to support changing member needs such as drawdown and/or income payouts as members move into decumulation. And it must be efficient to adjust in a timely and cost-efficient manner as well, to ensure reporting clarity. A modern default should feature clear, informative reporting across assets, flows, performance and attribution, charges, ESG and stewardship. Throughout, this should focus on the realised member experience after fees, helping to demonstrate value-formoney and highlighting the holistic

Defined Contribution Under the Microscope

fund-based approach makes TDFs the most versatile and capable default solution available today. The TDF structure allows the manager to make prompt changes to investments and to provide transparent member-level reporting on performance, cost, risk and ESG. TDFs are also easy for members to understand and use, enable a seamless transition from accumulation to decumulation, and take care of all the detailed implementation decisions automatically.

We offer

AllianceBernstein's approach in brief

impact of ESG actions. Full transparency should be provided to underlying holdings to support risk management and ESG reporting at both a plan and member level. Improving Member Outcomes The modern DC era brings increased demands for better member outcomes. These include: • Ease of member use: an automatic, do-it-for-me approach that allows for default members’ lack of expertise and unwillingness to engage • Post-retirement provision: members need a hassle-free seamless journey from accumulation to decumulation • Illiquid assets: exposure to previously excluded illiquid and private market return sources to enhance long-term returns and/or diversify risks • ESG integration across the underlying investments: continuous monitoring and Defined Contribution Under the Microscope

management to reflect the financial risks and opportunities that ESG factors pose • Cost-effectiveness: solutions that: combine high quality investment components; that can protect against inflation, mortality and longevity risks; and that charge very competitive fees Each of these needs can create additional challenges in terms of administration, investment expertise, governance and oversight, liquidity management and reporting. These challenges are becoming increasingly intractable for traditional default solutions. Ultimately, we believe pension providers will need to migrate to a modern default model based on dedicated fund vehicles. Choosing the Right Vehicle Target date funds (TDFs) are dedicated investment vehicles specifically designed for each cohort of members that shares the same retirement window. This dedicated

How Can AB Help? AB has experience in managing TDFs since 2005, with £58 billion invested for more than two million DC members globally. Those figures include investments in diversifying assets such as private markets, and in dedicated postretirement solutions. We create open architecture “fiduciary” DC solutions delivered via our TDFs. We provide analyses of membership profiles to help determine our TDFs’ investment objectives/risk and return parameters. And we supply transparent, detailed DC reporting to support clients and meet regulatory needs. Our investments have featured full integration of ESG factors since 2018. While our TDF model has remained unchanged over the years, the breadth and sophistication of the underlying investments and the scope of our reporting has expanded significantly. And it will continue to evolve seamlessly in future to address changing risks and opportunities, and new and different regulatory and member needs. Contact Us: For further details of AB’s TDF ranges please contact: Michelle Inskip Managing Director—UK Institutional Client Group T: 020 7959 4784 M: 07887 765 729 michelle.inskip@alliancebernstein.com

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Advertorial

Crunch time for credit investors Today’s conditions mean DC schemes must get dynamic

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Read More about Ninety One

Solar thermal power stations are playing a key rol

F

or over a decade, the low-yield environment has forced asset allocators to reassess their fixed income allocations. Today’s new era of higher inflation, rising rates and increased macro/geopolitical uncertainty brings a greater sense of urgency to the task. To meet their members’ investment needs, DC schemes need to embrace a dynamic, active and sustainable approach to managing their fixed income exposure across the glide path. This year, fixed income investors have faced a double whammy of rising yields and widening credit spreads. Monetary policy is a key driver of this shift: most central banks have begun to increase interest rates to tackle inflation and are retreating from bond markets, having been major buyers in recent years. War in Ukraine has further weighed on risk appetite and increased inflationary pressures. The environment of ongoing inflationary pressure and challenging forward-looking returns means members need to make use

Defined Contribution Under the Microscope

Among these, our Global Total Return Credit (GTRC) strategy is used by DC members as a key building block of their growth portfolio. We offer members access to the best ideas available across a broad universe of credit markets, without taking duration or currency risk. We seek to be defensive in downturns and to capture upside consistently through the market cycle, resulting in a smoother path of returns for members. GTRC can be an important, actively managed diversifier of returns within growth portfolios that are dominated by passive equities and traditional investment-grade fixed income.

le in the global energy transition

of the broadest possible opportunity set to generate returns through to retirement. In this context, an unconstrained credit strategy can play a valuable, diversifying role in a DC growth portfolio. Furthermore, as the age profile of DC members matures, successfully managing drawdowns is crucial for making portfolios downside aware in their growth phase. When compared with static allocations to traditional fixed income, unconstrained credit strategies (which can be truly dynamic) seek to offer members a smoother path of returns through to retirement. An unconstrained credit strategy, in which the manager has multiple levers to pull in search of attractive, bottom-up ideas in all market environments, can provide an effective solution for DC members who are looking to: • Diversify their existing portfolio, which has a passive equity bias and is underweight credit. • Implement a flexible building Defined Contribution Under the Microscope

block through an all-weather credit portfolio. • Add yield to the portfolio in a risk-controlled manner, while also outsourcing difficult asset allocation decisions within fixed income • Access a broad fixed income opportunity set - including specialist asset classes, which are difficult to access individually To address some of these challenges, Ninety One brings something different to the DC table, with a range of actively managed, sustainable DC solutions.

An unconstrained credit strategy can provide an effective solution for DC members

Reassessing fixed income In the past few months, our GTRC approach has seen us rotate into higher-quality market segments that had underperformed until recently. Using our full investment universe, we have also allocated to defensive investments such as short-duration credit. We think these areas offer a good balance of potential upside if markets improve and downside protection should volatility remain high – an important balance when pursuing a smooth path of returns. The long-term time horizons of a DC scheme member and sustainability considerations are intrinsically linked. A young DC member today will almost certainly witness the global energy transition in their lifetime, creating new risks and opportunities to navigate in their retirement portfolios. To combat this, our Credit team has developed a sustainability framework, including a forward-looking Transition Alignment evaluation, which assesses transition risk for all holdings. We believe a reassessment of fixed income allocations within DC portfolios is needed. In the era of rising inflation, challenging forward-looking returns and an urgent energy transition, DC members should embrace a dynamic, active and sustainable approach to managing their fixed income exposure.

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Guest View

Sonia Kataora Barnett Waddingham “How to build a modern default design ”

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Read More about Barnett Waddingham

For Professional Use only and should not be construed as advice

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W

ith inflation reaching a 40-year high in May and the prospect of rising interest rates alongside continuing market volatility, the use of passively-managed equities and bonds by many DC schemes in the past may not prove as robust in the future. For example, most asset classes struggle to generate above-inflation returns during short periods of high inflation. In addition, with yields having fallen so low in recent years, some are concerned that the historic negative corelation between equities and bonds will become less potent during the next extreme market event. While we expect the historic relationship to endure, we recognise this as a legitimate concern and so it’s worth looking to see what tools we have in the toolbox to build cost effective strategies that will offer real value for DC members. Knowing your members… The challenge is that we are often designing strategies to cover a wide range of possible outcomes. Whilst this means that pragmatism becomes the name of the game, member segmentation can help improve the odds beyond hoping that a default strategy will work 80% of the time for 80% of the membership. For example, we know that a person’s age is likely to influence how they prioritise retirement saving, and affluence shapes an employee’s likely ability to do so. This can be translated into different retirement targets (like the PLSA’s Retirement Living Standards). …can help build intelligent defaults There is no reason why the default needs to be a single path and applying logic based on a member’s expected pot size can help to offer a strategy more in tune with a member’s needs (e.g. directing members to a cashtargeting or drawdown-targeting strategy). The ultimate desire is to allow members to select appropriate strategies for different objectives at different timescales

Defined Contribution Under the Microscope

(e.g. if members plan to take a series of lump sums, ‘switch on’ different levels of income at different ages and/or leave an amount for inheritance). We need to make it easy for members to follow a simple process that results in a bespoke, sophisticated investment strategy that meets their needs. More recently, we have seen DC providers changing the pace of lifestyle switches according to market conditions (e.g. reducing risk if targets are met to conserve the amount of savings built up or continuing to invest in higher return-seeking assets for longer if targets have not been met). Whilst there is value to be had in tactical asset allocation carried out by investment managers within the remit of a fund (e.g. target date funds), tactically altering the glidepath of a lifestyle strategy is administratively more complex and the potential for regret risk can be high. But what about intentionally running different levels of risk for different cohorts of members (e.g. women or those taking career breaks)?

Volatility can be your friend The onset of the COVID-19 pandemic in early 2020 and the Russian invasion of Ukraine this year have been dramatic reminders that such ‘extreme’ events can strike at any time causing havoc to markets and members’ savings if not properly insulated. But such volatility can offer opportunities for younger members who are making regular contributions, although the benefit of volatility falls away quickly as time horizons shorten. This means market timing – or perhaps ‘luck’ is a better choice of word – becomes increasingly important. It effectively comes down to when a member starts contributing. Knowing this, how could it affect default strategy design? First of all, it raises questions over whether it is worth paying for volatility control to achieve ‘equitylike returns’ early on and therefore calls into question the value of diversified growth funds or currency hedging when members are so far away from retirement.

Diversification from public markets can help improve the ability to achieve members’ retirement goals

Defined Contribution Under the Microscope

Secondly, does the importance of time horizon and luck lend itself towards slightly longer glidepaths, particularly when targeting cash? The right kind of diversification at the right time The above is not evidence for relying completely on traditional equity markets when members are young. There is still value in accessing different risk premia in search of returns. For example, diversifying into private markets can mean members are less exposed to the vagaries of public markets. There are also a number of longer-term trends that are affecting the supply and demand of capital to private markets (including from a sustainability angle). Many of these trends align with the long-term investment horizon of DC members. Better retirement The importance of supporting members at retirement to convert their savings into a lifetime income is more pressing than ever. Many retirees are reluctant to pay for financial advice and are currently tackling this challenge by themselves. This is resulting in significantly less than optimal outcomes for many people and undermines a lot of the gains made by DC scheme members during their accumulation phase. For example, our research has shown that individuals could lose up to 10 years of pension contributions simply by switching away from their occupational DC scheme into a retail solution. At Barnett Waddingham we draw on the behavioural theory of Maslow’s hierarchy of needs to inform how the level of income required to support living standards changes through the different phases of retirement. We can then derive a default decumulation strategy, underpinned by a default investment strategy, that accounts for these different members’ needs (e.g. combining drawdown with an annuity element).

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Focus on ESG to Engage Members

Solving the riddle of member pension engagement At long last, the tide could be turning D on member engagement – thanks to ESG and impact investment

C pension schemes have been trying long and hard to engage members, with little success. But the tide could be turning, because of the greater role ESG and impact investment is playing in shaping investment portfolios. If schemes can paint a vivid picture for savers about how their money is being used to do good, combat climate change and further sustainability goals, they might sit up and take note, a panel of experts agreed at the Virtual Panel’s ESG & impact investment roundtable.

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Watch the round table recording

Why does engagement matter and what can schemes do to improve it? Ultimately, there are two levers which will help DC savers to improve their chances of a comfortable retirement. Is their default fund invested in a way that will help members to achieve their Defined Contribution Under the Microscope

Click the Image to watch the webinar Top row: Matt Johnston, Keillian Tai, Julius Pursaill Bottom row: Caroline Hopper, Alison Henry

Take Aways

1

ESG could be the secret to unlocking member engagement. The more members save, the better their chances of a comfortable retirement. If they understand where their money is invested and feel their money is having a positive impact, they might save more.

2

There are a number of ways schemes can capture members’ imaginations. Listening to what members care about, offering them the chance to have their say and meeting them where they are could all transform engagement.

3

On the flip side, schemes which ignore ESG or rely on simplistic ratings risk turning members off. Where possible, schemes should seek investment managers which invest in companies at the forefront of positive change, instead of screening out perceived ESG offenders.

Defined Contribution Under the Microscope

objectives? And are their contribution rates high enough? The more members put aside for retirement, the better. That’s why engaging them matters, explained panellist Keillian Tai, a senior vice president at Redington. So, how can we capture people’s imaginations? When members discover that their pension money is invested and can be used to do good things, it can be a lightbulb moment. That’s why ESG and impact investment is so powerful. Find out what your members care about and use it as a basis to talk to them about what their pension money is doing, suggested Caroline Hopper, lead consultant at Quietroom. Conducting a member survey is one way to get this information. Focus groups are another way of hearing their input. “Even speaking to five members will give you a good sense of what

The Panel

Alison Henry is a Director at Baillie Gifford Julius Pursaill is Strategic Advisor to Cushon Mastertrust Caroline Hopper is Lead Consultant at Quietroom Keillian Tai is a Senior Vice President at Redington. Matt Johnston is the founder and CEO of the Virtual Panel. He moderated the event.

19

New ways of doing old things: Reducing emissions Meat from peas? — Same (or lower) price; same taste; more healthy

Food

— 99% less water, 93% less land, and 90% fewer emissions to produce than animal meat — ESG score? — Over 90% of Beyond Meat’s target customers are non-vegetarian

Beyond Meat is one example of a growing company which is making the planet better

you Baillie needGifford. to do,”Investing explained Hopper. for Positive Change. Once members understand that their money is invested, schemes should give them a way to get involved. Creating a member panel is one idea to consider. Another is offering members access to a voting platform like Tumelo, which gives them the option to have their say on how their investment managers are voting at AGMs. Julius Pursaill is one fan of this approach. “I think we are going to move to direct transition of member preferences to the fund manager,” said Pursaill, who joined the panel in his capacity as strategic advisor to master trust Cushon, but also advises Tumelo. Meeting members where they are is also important. The vast majority of pension schemes – as well as the wider industry – do not have a presence on social media. But campaign group Make My Money Matter has found a way to talk about pensions on Instagram, points out Hopper. If they can find a way, others can surely follow their lead. The risks of ignoring ESG On the flip side, investing in ESG offenders risk turning people off. Schemes that invest in funds which rely on ESG scores could still be

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exposed to climate offenders, tobacco companies and more. “ESG scores are too simplistic,” argued Alison Henry, a director at Baillie Gifford. “The industry is ending up with ESG screens that may pick leaders using a tick-box approach but miss the bigger picture of the sector in which they operate,” Henry explained, with reference to the tobacco industry. Companies which are currently in the top ten highest ranked companies by total ESG score include Phillip Morris and Altria, which are both tobacco companies. This is because ESG scores take a composite measure of how companies are performing in areas like carbon footprint and diversity. Henry continued: “Of course, none of this is taking into account

The industry is ending up with ESG screens which miss the bigger picture of the sector in which they operate

that the users of their products 23218 10011703are6 addicted to something that's making them ill and is raising death rates and of course, it's putting a lot of strain on society's resources. So, we've got a bit of a mismatch there.” Pension schemes can screen out tobacco companies and other traditional ESG offenders, but they will end up with a portfolio which is weighted by very narrow criteria, which does not account for the purpose and real-world impact of companies. To engage members, it’s time to move on, argue Baillie Gifford. Fund managers should flip the way they invest, buying shares in exceptional companies rather than steering clear of the worst ones. Henry said: “Are members going to be engaged if they see a tobacco company receive an overweight in a portfolio because they have good written policies? No.” Beyond Meat is one example of a company which is moving the dial. With its plant-based alternatives, it is not just appealing to vegetarians, but to meat eaters who want to cut down their carbon footprint. The company boasts strong environmental credentials. It can provide tangible evidence it is improving the world, which will resonate with DC members (see Defined Contribution Under the Microscope

BAILLIE GIFFORD POSITIVE CHANGE

Constructive capitalism. With your help it can power positive change. A bold statement, but we truly believe that capital thoughtfully and responsibly deployed can be a powerful mechanism for change. Our Positive Change Fund seeks to identify high quality growth businesses who are providing solutions to global challenges. We think those businesses will prosper and flourish, at the same time delivering attractive returns to your portfolio. Want to help us power positive change? The value of investments and any income from them may go down as well as up and investors may not get back the amount originally invested. To find out more about investing for positive change visit bailliegifford.com

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Baillie Gifford & Co. and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority.

image, top of p20). Despite its mission, Beyond Meat is ranked 12,788 by one ESG ratings agency. Why? As a growing company, it has a growing carbon footprint – even though it is moving the world to a better place in terms of protein production. It is also punished by ratings agencies because of its poor disclosures. This criticism has merit, but Beyond Meat is a young, fast-growing company, and is working with its investors to improve disclosure. A live debate Impact reporting remains a live debate – and schemes have cost, time and governance constraints. “The biggest issue with impact reporting is that Baillie Gifford isn’t going to be their single fund manager,” said Tai. “Fund managers can focus in on smaller number of holdings and come up with very specific impact measurements. But for a trustee, that is one of many other funds they own. How can they aggregate all that into something which is digestible for members? You get pockets of innovation in this, but how do you bring it all together? This is one of the things ESG scoring metrics helps with – it is fraught with issues but provides a starting point that can be a measuring stick and trustees can map things more broadly and use it as a channel of communication for members.” That said, discovering their money is invested in objectionable companies could be enough to turn a pension saver off. Hopper recalled what happened when researchers Ignition House interviewed some DC pension savers, as part of a group research piece for the DCIF. Hopper said: “We asked DC members what they knew about their pension. Did they know their money was invested? Did they know what it was doing? We watched as every single one of these people had that moment where the cogs were turning and they realised, ‘My money's invested, I need to look into it. I want to find out what it's

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One saver finds out the types of companies his pension could be invested in, if it were invested responsibly. Source: Quietroom

doing. If it’s doing good. I would even save more.’ Most came to their own conclusion that their money doing good was probably the best way to make it grow, without us even having to talk about that. Watching that really crystallised the power of responsible investment for me.” Another criticism which trustees sometimes level is that it is impossible to align ESG and impact investing with the trustee’s fiduciary duty to invest in members’ best interests. But some trustees believe it is entirely possible to

Members came to the conclusion that their money doing good was probably the best way to make it grow

invest in the round, taking both considerations into account. Once a scheme has achieved higher levels of engagement, it can encourage people to make better financial decisions, argued Pursaill. More engaged members do make better financial decisions, and therefore, better financial decisions lead to better financial outcomes for members. Although it isn’t without complexity, finding ways to prioritise ESG and impact investment are worth the effort. As Pursaill concluded: “We have failed to engage members in DC land for 30 years. It has been a colossal waste of money. It is nigh on impossible to engage people with something which is intangible and 25 years away. But thanks to ESG, this is changing. At Cushon, our members feel proud of their investment today. Our employers get better value – today. They feel good about the pension their employer has chosen. That emotional connection is incredibly important. It is not an end in itself – it is a means to an end, and the end is better investment outcomes.” Defined Contribution Under the Microscope

Who are we? We’re a group of asset managers who believe that a well-designed and diverse investment strategy has an important role in delivering a comfortable retirement for millions of DC savers. A not-for-profit organisation, we commission and publish research which shines a spotlight on DC investment issues. We hope the people who determine DC pension schemes’ investment strategies will use it to inform their work.

Our members

We also arrange events. From virtual roundtables to in person gatherings, they’re a great way to learn more about DC investment issues and meet a like-minded community of trustees, pensions managers, investment consultants and more. To find out more about our work and explore membership options, please visit: www.dcif.co.uk

Our members shape the DCIF’s direction and steer research projects. They are:

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Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority. Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs. All data is sourced from Baillie Gifford & Co unless otherwise stated. As with any investment, capital is at risk. Past performance is not a guide to future returns This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

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aving spent the last few centuries plundering the planet and living with huge income disparities, can humankind start to take bigger strides in the race to repair the damage? According to Baillie Gifford’s Positive Change team, the spotlight now falls on innovative companies. As they see it, their job is to seek out and support the firms best placed to help move us to a more prosperous and inclusive society and a more sustainable planet. These are the pioneering firms that, aligned with investors, governments and enlightened consumers, can help tackle the big, complex and often interlinked global challenges. Among them are climate change, biodiversity loss and rising income inequality. The team believes that companies that are developing products that meet social and environmental needs are likely to prosper over the long-term, making impact investing an exciting opportunity for defined contribution pension schemes. Sustainable materials Growing populations mean greater demand for materials made from resources that are increasingly scarce, environmentally damaging, or both. For example, fashion is becoming faster and cheaper. We are consuming more clothes and using them less frequently, and, as 60 per cent of textiles are made using petrochemicals, the system has a huge environmental impact. We need to move away from an ‘extract, use and dispose of’ system to one where we make things from more sustainable materials, keep them for longer and dispose of them more responsibly. Synthetic biology is a field of science that involves designing organisms for useful purposes by engineering them to have desirable characteristics and abilities. Japan’s Spiber, for example, uses synthetic biology to create entirely new, better textiles. Its custom-made fibres are made from proteins that are manufactured on an industrial

Defined Contribution Under the Microscope

Agricultural equipment is another way we can improve farming productivity while reducing its negative environmental impact. This is crucial for a more sustainable food system in the future. In this area Illinois-based Deere uses technology to reduce pesticide and fertiliser use. This is helping the system to improve through precision agriculture tools. John Deere machines are equipped with cameras and sensors and use machine learning to spot crop versus weed. It means they can reduce herbicide and pesticide use by up to 80 per cent. This helps farmers improve yields while reducing consumption of these harmful products.

Pioneering synthetic biology companies are offering alternatives to fast fashion

scale and are biodegradable. We can make ‘better’ materials and move towards a more circular economy – a system in which materials are retained for longer. Brussels-based Umicore is contributing towards this goal. It has three parts to its business, and all have interesting positive impacts on society. They are metal recycling, which reduces our need to extract raw materials; automotive catalysts, which improve exhaust emissions and reduce pollution; and battery cathodes, which reduce the cost of batteries for electric vehicles, making them more affordable and accessible. Sustainable agriculture Just as we need to change our fashion habits, we also need to address how we eat. The agricultural sector is responsible for 20 per cent of emissions and 70 per cent of global water Defined Contribution Under the Microscope

consumption and is the leading contributor to biodiversity loss. How can we address that? Since 2009, Beyond Meat has been developing healthy, plantbased meat alternatives that mimic the taste and sensory experience of animal meat but have a far lower environmental impact. The firm has partnered with big food chains such as McDonald’s and Starbucks, showing signs that a brand advantage is emerging.

We are consuming more clothes and using them less frequently

Financial inclusion Helping the financially excluded is important because at least half the population of many emerging markets lacks access to financial services. Indonesia’s Bank Rakyat provides microfinance – small loans, lowdeposit savings accounts, lowpremium insurance – to the otherwise unbanked, helping to enable financial inclusion and inclusive growth. Its advantage is a very extensive network of rural agents and bank branches; Indonesia is a vast country with thousands of islands and other banks cannot build up an infrastructure to compete. Similarly, Nu Holdings, a digital bank in Latin America, is helping to promote financial inclusion by providing cheaper and more accessible services, including bank accounts, credit cards and personal loans. There are about 134 million unbanked adults across Brazil, Mexico and Colombia, with the rest of the population receiving a substandard but expensive banking service. Nu can play an important role in fostering innovation and competition. Although Nu is not the only fintech player in Latin America, by virtue of the company’s scale and success, its impact has been far greater.

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P

eople are starting to wake up to the fact that their investments can be a powerful force for change; they want their money to be doing good things for them as well as the wider world. For a lot of people, their pension is the biggest or only real investment they have, and so it’s no surprise that in the world of pensions, more sustainable investment approaches are being demanded by members, especially around climate change where financed emissions are staggering. We’ve calculated that the average UK pension scheme helps finance 23 tonnes of carbon emissions a year through the businesses it ultimately invests in. Now, this is a huge amount, equivalent to running 9 family cars each year or burning 1,100 coal fires annually. When you then consider the fact that there’s about £2.7 trillion in total invested in UK pensions, that’s a lot of carbon that’s being financed just from pensions.

Guest View

Steve Watson Cushon Mastertrust “How to create sustainable pensions as a tool for improving member outcomes”

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Read More about Cushon Mastertrust

The pensions disconnect People want change but the historical problem with pensions is that people don’t engage with them – inertia is a massive problem. But from our own research, we found that the majority (62%) of pension members would engage more if they knew their pension was having a positive impact on climate change. Making pensions more sustainable not only positively impacts environmental issues, like climate change, but it also gets people engaged with their pension savings which leads to them paying in more and ultimately results in better member outcomes. The best way to explain this is to firstly look at why traditional investment strategies have very little influence on engagement levels. If you were to ask the average person on the street where their pension is invested, they might name their employer. If they are better informed, they might name their pension provider. If they are really interested, they might be able to name the actual fund they are invested in. But very few, if any,

Defined Contribution Under the Microscope

Pension savings can do good for our world, helping to shape a future worth saving for

will be able to name the underlying companies that their pension is ultimately invested in. There is a real disconnect between members and their investments. It's just a cold, hard fact of saving for retirement – there’s no emotional attachment. Pensions with purpose The best way to get members reconnected with their pensions is by investing in companies or projects that are meaningful from a greater purpose perspective. The problem with traditional investment approaches is that the focus is primarily on returns. Even if there are some “sustainable” elements, it’s not easy for members to see the good that their pension is doing on the ground. Without this direct link, there is little scope for connection. Defined Contribution Under the Microscope

More sustainable investments on the other hand, can offer a direct link to on-the-ground investments allowing members to create a connection between their pension and real-world change. Imagine the ability to show members content from a project that their pension is directly invested in and is making a

Our research found that people would engage more if they knew their pension was having a positive impact

difference in the world. They get regular updates on what is happening with their investment and the difference it’s making to people’s lives and the wider world. It’s not just about investment returns or their annual pension statement anymore; it’s about the power of their pension to make a difference – it’s creating an emotional connection. It’s this emotional connection that creates engagement and it’s engagement that ultimately has a massive impact on retirement outcomes. The more engaged pension members are, the more likely they are to make good decisions around their pension – how much they’re contributing and where they are invested. After all, it’s the contribution amounts that, over time, make the biggest difference.

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Guest View

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s an industry, everything we tell members about pensions positions them as something to ignore. We make them sound: • Far away. Whether retirement is 3 months or 30 years away, nothing about a pension is happening now. • Intangible. What does a pension look like? It’s invisible. It’s easy to ignore what you can’t see – and save up for something you can, like a house. • Hard to understand. Everything sounds confusing. Risk? Return? Salary sacrifice? (When has ‘sacrifice’ ever been a good thing?) • Passive. As a member of a pension scheme, your money just… leaves your payslip. You don’t do anything to make that happen. The result: pensions are Something To Not Care About. And herein lies our problem. If we want to get members to do anything about their pension, they have to care. That’s because humans make decisions based on emotions, and only then back them up with rational facts.

Caroline Hopper Quietroom “Responsible investment: giving members a reason to care about their pension”

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So, how do we get members to care? The proven answer is: responsible investment. When we bring responsible investment to life for members, pensions become something that’s: • Happening right now – the money that leaves your payslip is invested in companies, and those companies are doing real things – right now, every day. • Tangible and real – your money might be creating jobs, building solar panels, or influencing the board of that big company you’ve heard of to make it more diverse. Pensions aren’t invisible any more. • Easier to understand – risk and return means nothing if you think your money’s sitting in a savings account. But if you know it’s invested in the real world, it starts to make a little more sense. • Powerful – a pension is no longer something that’s done to you. It’s Defined Contribution Under the Microscope

something you’re doing – you’re investing. And together, you and your pension scheme have the power to make change. Showing members what their money’s doing gives them a reason to care, and that can unlock big opportunities. If members care, they’re more likely to engage. If they engage, they’re more likely to register online, nominate their beneficiary, contribute more – whatever action it is that you’re looking for them to take. Research shows this could unlock £1.2bn in contributions. Even in the beginnings of the cost of living crisis, people still said they’d contribute more if they knew their money was doing good. That’s financial resilience boosted. It’s more money invested today to fund the solutions of tomorrow. It’s good for our members and good for the whole planet. How do we do it then? How do we bring responsible investment to life for our members? There’s a whole spectrum of ways, which you’ll see below. Some schemes show members examples of investments in newsletters, or ad hoc comms. Others run webinars and roundtables, to hear member views

Why can’t we get members to engage? Because we make pensions sound like Something To Not Care About. and let them ask questions. Some build impact tools to show members their pension’s carbon footprint, use Tumelo to give members a say in how the companies they invest in are run, and even take members on trips to see their investments for real. The communications that work best do three things:

best kept secrets. Until now. The rest of the finance world – retail investment, banking, insurance – is moving in on this. In the next year, expect to see the consumer space flooded with messages that help people make the connection between their money and the real world. But why wait for that, when you can tell your members now – and reap the rewards of engagement? To see what it looks like when people make the connection between their pension money and the real world, watch our video.

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They fill in important gaps in understanding. Responsible investment makes no sense if you don’t know that your pension is invested in the first place. They tell stories that make investments tangible. They show how these investments are good for your pot as well as for people and planet. The fact that money can do good while it grows is still one of the

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Bringing responsible investment to life for members – a spectrum

Large pull quote goes in here to help break the page up and add interest Defined Contribution Under the Microscope

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Focus e on Privat Markets

The time is right for DC investors to consider private markets Schemes can enjoy superior returns for members – while supporting the energy transition

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Watch the round table recording

Times are changing for DC investors DC investors have long bemoaned the difficulties associated with accessing private markets. However, times are changing. Today, thanks to a combination of industry and regulatory effort, combined with strong growth in DC assets under management, these markets are opening up to DC investors, creating a new world of opportunities. That said, investing in private markets does require more effort and due diligence from trustee boards and their advisers. Is it worth the effort? A cross-industry group of DC professionals joined Matt Johnston, founder of the Virtual Panel, to discuss when investing in private markets is worthwhile for DC schemes – and whether they can access them in practice today.

Defined Contribution Under the Microscope

Click the Image to watch the webinar Top row: Matt Johnston, Matthew Roberts, Tim Horne Bottom row: Stephen Budge, James Lawrence

Take Aways

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A combination of regulatory change, industry effort and growing scheme appetite is putting private markets on the menu for DC pension schemes. But is investing in private markets worth the effort? Are there governance-friendly solutions available?

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A panel of DC industry professionals argued that the effort is worth it. Private markets will help DC schemes to diversify away from equities, to play their part in the energy transition, to help fight climate change and this comes with the potential to offer superior returns and/or risk reduction.

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The barriers to investing in private markets are coming down, as we explore in our Q&A.

Defined Contribution Under the Microscope

Why should DC investors consider private markets? Private market investors gain access to companies and sectors which are inaccessible via public markets. “The opportunity to build diversified portfolios across the breadth of these opportunities is really interesting,” explained presenter Tim Horne, head of UK institutional defined contribution at Schroders, as he opened the event. While the cost of accessing private markets will be higher than mainstream asset classes, schemes can hope for potentially better risk-adjusted returns, thanks to the knowledge and resources of specialist private market managers. Investors in private markets are much closer to the assets and often have greater influence. A pension scheme may own a private wind

The Panel

Tim Horne is Head of UK Institutional Defined Contribution at Schroders Matthew Roberts is Partner and Head of Alternative Solutions at Fulcrum Asset Management. James Lawrence is Head of Investment pProposition at Smart Pension Stephen Budge is a Partner and Head of DC Investment Strategy at LCP Matt Johnston is the founder and CEO of the Virtual Panel. He moderated the event

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The climate investment landscape Identifying and targeting key areas of investment for positive climate impact

The deployment of clean technologies across core business sectors could help reduce 64% of global energy emissions by 2050

Net-zero emission objective expands global energy-related investment from ~$2trn pa today to ~$5trn by 2030 expanding capacity from 143GW to 630GW by 2030

Building and construction are responsible for 39% of global carbon emissions and represents the largest single waste stream in many countries

More than half of the world’s gross domestic product, $44 trillion, involves activities that are moderately or highly dependent on natural resources. If nothing is done WWF estimates costs of $10trn by 2050

Private Equity

Infrastructure

Real Estate

Natural Capital

✓ Drive innovation and growth of clean technology ✓ Help avoid climate disaster

✓ Central role for private investment in the energy transition ✓ Expand the capacity of renewable energy production

✓ Target reduction in waste of single largest contributor

✓ Essential to meet worlds net zero targets

✓ Directly reduce carbon emissions and positive social impact

✓ Food security and biodivsersity

Source: Schroders Capital, 2022.

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farm or have a stake in a private company. Using that ability to influence how that asset is managed means you can drive the DC direction of travel in a way you couldn’t with a public asset. In the DC world, sustainability and impact investing are high on many schemes’ agendas. This is starting to influence how scheme fiduciaries are allocating capital. Private assets offer the opportunity to invest in a range of opportunities which offer investors the chance to have a real impact. Why sustainability and impact go hand in hand with private market investing As we transition to a more sustainable economy, private markets offer DC schemes the opportunity to play their part in a virtuous circle. Many large companies with DC schemes have made net zero commitments, as have most DC master trusts. Significant capital must be allocated to companies which further those objectives if we are to meet emissions reduction targets by 2050. As presenter Matthew Roberts, partner and head of alternative solutions at Fulcrum Asset Management said: “There is a unique opportunity in the DC

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market over the next five to 10 years as many schemes consider private markets. There is the chance to deploy money, gain access to idiosyncratic opportunities and access human ingenuity that contributes positively to the transition. We have to do this if we are going to meet net zero targets.” Private capital will have a massive impact on the world’s ability to make the journey to net zero. Some of the companies which are playing a key role in the energy transition are young innovators which are unlikely to be listed in public markets. By investing in areas like private equity, infrastructure and natural capital, DC schemes are helping those

There is a unique opportunity in the DC market over the next five to 10 years as many schemes consider private markets

companies to grow. Equally, because of the role they are playing in the energy transition, these companies offer the prospect of strong returns. Natural capital is one example of an asset class which requires investment. If we do not look after our ecosystem, it is going to have a major impact on the viability of many businesses. Natural capital offers investors the option to invest in biodiversity, the better use of water and pollination services, for example. Real estate is perhaps a less obvious private asset class which can play a role in the sustainability journey. As the graphic above illustrates, building and construction are significant sources of emissions; investors can work with developers, as well as with existing owners, to make properties more energy efficient. Private Markets Q&A: Your private markets questions answered The panel examined some of the reasons why DC investors have found it hard to access private markets. A combination of flexibility, innovation and perspective is needed to find a solution to these challenges, argued Roberts. Here are some of the most common barriers – and Defined Contribution Under the Microscope

Pic caption goes in here

what is being developed by industry and regulators to try to overcome them.

The Long-Term Asset Fund (LTAF)

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Isn’t it impossible to reconcile daily dealing with illiquid investments? The creation of the Long-Term Asset Fund (LTAF) will make it easier to bridge the gap between the daily dealing requirements of DC schemes and the inherent illiquidity of many private market asset classes. Numerous asset managers are developing LTAFs for DC pension schemes, working closely with the Financial Conduct Authority, reported Horne and Roberts. Do platforms accommodate private market funds? Panellist Stephen Budge, who is a partner and head of DC investment strategy at LCP, reported: “We have seen platforms becoming much more accommodative of different structures over the last couple of years. The industry focus has really helped, and support from government and regulators is enabling platforms.” Budge caveated: “Not all platforms are in the same place; some are definitely ahead of others. We are still in a period of waiting for the market to develop.”

Why is the LTAF a positive development? 1. Platform Friendly: rewriting some of the old rules which were a barrier 2. DC-Specific: reigniting (genuine) innovation for DC 3. Open-ended Hybrid Liquidity: required flexibility within set boundaries

The benefits of the LTAF

think about private assets in the same way as any other asset class which forms part of their wider strategy. These are asset classes that have some different properties, but they have to be right for your scheme before you consider them.” Horne added: “If your DC scheme is about to move to a master trust, now is probably not a good time to put some of your investments in illiquid assets.” What does a typical allocation look like? Budge reports his clients tend to invest around five to 15% of their

I am unsure where my scheme should start. Investing in an LTAF which contains a diversified mix of private market strategies is one option to consider. Most LTAFs are still going through the regulatory approval process, but this panel proved that there is clear appetite among asset managers with a specialism in private markets. Early 2023 seems to be the most likely launch date for these LTAFs. When might private markets be inappropriate for my DC scheme? Schroders’ Tim Horne advised: “It's really important for any scheme to

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total assets under management in private markets, depending on their governance resources, budget and internal structures. Panellist James Lawrence is head of investment proposition at Smart Pension, and responsible for making such decisions on the ground. Lawrence said: “We have 10% in private debt at the moment, and we will hopefully be towards the upper range of what Budge mentioned in terms of our total allocation – we are probably looking at around 15-20pc total. Equity has been the trickier part; it is great to see that the managers on the panel have built private equity solutions. We think the opportunity set is huge.” What level of return should I expect?

We have seen platforms becoming much more accommodative of different structures over the last couple of years

And what about fees? Fees used to be a real barrier – but managers are finding ways to democratize access. Both Schroders and Fulcrum charge a flat fee, with no performance fees. Schemes can expect returns in the high single digits net of these (albeit higher than public markets) fees. The evolution of private markets shows how nimble the DC pensions industry can be. This can only be positive for members, who will gain access to a diversified range of assets, while delivering impact. Defined Contribution Under the Microscope

For Professional Investors Only

Alternative Solutions for DC Savers Our focus is on building innovative, ESG integrated, alternative investment solutions. Specifically designed for DC investors, our strategies provide exposure to a wide range of liquid and illiquid underrepresented asset classes. For further information on any of Fulcrum’s investment strategies, please contact chris.gower@fulcrumasset.com fulcrumasset.com

This material is for information only and is not intended to be re-distributed. It is directed at professional clients and eligible counterparties only and it is not intended for retail clients. Redistribution or reproduction of this material in whole or in part is strictly prohibited without prior written permission of Fulcrum Asset Management LLP (Authorised and regulated by the Financial Conduct Authority, No: 230683). © 2022 Fulcrum Asset Management LLP. All rights reserved. FC083 010722

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Impact in private markets for UK DC investors Private capital must play a key role in reaching net zero

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n recent years we have seen a step change in the landscape of the defined contribution (DC) pensions market. As the market continues to consolidate, and larger schemes and master trusts see their asset bases grow, so too does their buying power and ability to direct capital into new areas of the market. Backed by the UK government, the FCA has already taken steps to remove some of the regulatory hurdles that previously prevented DC schemes from investing in private markets. The launch of the Long Term Asset Fund (LTAF) is designed to allow DC savers to invest in illiquid assets through an open-ended authorised fund structure, removing much of the red tape which previously restricted the market. But the plans are still nascent in their development, and as yet are largely untested. Investment in private markets has long been considered a natural fit for DC investors due to the long term nature of their investment horizon, and yet until now take-up has remained remarkably low relative to their DB counterparts. Concerns around lack of liquidity, additional governance requirements, and higher management fees have been seen as

By Tim Horne, Head of UK Institutional Defined Contribution, and Tom D’Agostino, Client Director, Schroders

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Defined Contribution Under the Microscope

a barrier to investment by Trustees. And yet the benefits for DC investors are clear: private markets can not only offer investors with higher risk adjusted returns than they would typically receive from liquid assets, but also offer a great source of diversification due to the lower levels of correlation with public markets. If we explore ‘the why’: simply put, private markets offer a breadth of opportunity which is not available through public markets. If we look at private equity investments for example, investors have an opportunity to invest in young companies at the forefront of innovation in high growth areas of the market. While by contrast an investment in infrastructure can provide access to stable cashflows from contractual assets, and ownership of a ‘real asset’ that the investor can take control of. Accessing these assets requires a greater degree of skill and experience than public markets, and it is this ‘complexity premium’ which means the reward for allocated capital can be higher. Sustainability, and in particular understanding the risks posed by climate change, has also never

been higher on Trustees' agenda. We have seen an increasing number of schemes set ambitious decarbonisation targets, and seek to align their investment to a net zero pathway through initiatives such as the Paris Aligned Investor Initiative’s Net Zero Asset Owner Commitment. Many of us will be familiar with the findings of the most recent IPCC report stated that without deep and meaningful reduction in emissions across all sectors, limiting temperature rises to 1.5c is beyond reach. In order to deliver the required savings, significant investment is needed in both infrastructure and technology. Private capital is therefore going to have to play a pivotal role. If we hope to achieve the targets set in the Paris Agreement and reach net-zero emissions by 2050, the UN’s Net Zero Financing Roadmaps estimate that over 70% of the direct investment needed to reach net-zero will need to come from private investment. But the challenge has remained how to bring this opportunity set to members in a way that they can access through DC default funds. The requirement for liquidity has

proved problematic, particularly for platform providers that have historically relied upon receiving daily pricing. And the segmentation of the market has meant that investing directly in private assets has been out of reach for all but the very largest pension schemes. However, at Schroders we believe we have developed a solution that can solve these issues. Schroders Capital Solutions – Climate+ A multi private assets impact portfolio Schroders Capital Solutions Climate+ (“Climate+” or the “Fund”) is a diversified multi private assets solution intended to contribute to the adaptation to and mitigation of climate change. The Fund delivers a diversified portfolio of private assets within a single, low governance, pooled structure, with the commitment to focus capital on delivering real climate impact. Crucially, the strategy will be delivered in an opened structure, making it accessible to a range of institutional investors including DC pension schemes. Marketing material for professional clients only

Source: Schroders Capital, 2022

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e have a relentless focus on innovation and with that in mind, our Alternative Solutions team builds highcalibre, complementary alternative investment strategies that improve accessibility for investors, particularly DC Schemes. As part of the 2020 Budget, the UK government announced a review of the UK’s fund regime. The Productive Finance Working Group produced “A Roadmap for Increasing Productive Finance Investment” to help drive long-term investing and promote illiquid access for DC schemes. We have followed the LTAF’s development closely, culminating in the FCA announcing the LTAF as a new category of open-ended fund in November 2021. Whilst no fund structure is perfect, we believe the LTAF overcomes many of the previous hurdles for DC, thereby allowing schemes and their members to access private markets.

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Allocating to Illiquids in DC – the LTAF Revolution LTAFs will help DC savers – but more innovation is needed

The benefits: Platform friendly LTAF legislation rewrites some of the laws that, historically, have made it very difficult for investment platforms to hold private assets. We have seen a flurry of activity by platforms to facilitate LTAF structures and administer them on behalf of their clients following these changes. DC-specific funds Before the advent of the LTAF structure, investment innovation for DC savers had stagnated. The new regime has provided a welcome springboard from which to innovate.

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This material is for information only and is not intended to be re-distributed. It is directed at professional clients and eligible counterparties only and it is not intended for retail clients. Redistribution or reproduction of this material in whole or in part is strictly prohibited without prior written permission of Fulcrum Asset Management LLP (Authorised and regulated by the Financial Conduct Authority, No: 230683). © 2022 Fulcrum Asset Management LLP. All rights reserved. FC084 040722

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Open-ended hybrid liquidity The LTAF seeks to bridge the gap between closed-ended drawdown structures and fully open-ended daily-dealing funds. It offers a framework to compromise between the two whilst to allowing a range of liquidity options.

Defined Contribution Under the Microscope

esign is of Paramount Importance Structured Credit

UK Social Housing Change of Use Real Estate

Secured Lending

Real Estate

Credit

Value-Add Real Estate

Opportunistic Credit

Fulcrum LTAF

Clean Energy

Venture

Private Equity

Infrastructure

PreIPO/IPO/ Illiquid Small Cap

Technology Infrastructure

Natural Resources

Electrification

Timber & Farmland

CoInvestments

Water

Agriculture

Fulcrum’s LTAF enables DC savers to access a wide range of alternative assets

Flexibility, Innovation and Perspective

Whilst the LTAF is a positive regulatory development, we still um Asset Management LLP. For illustrative purposes only. need to find investments that work for DC savers. This is easier said than done – mainly as the design of DC pensions is not a natural fit with the current operating model for many private markets managers. In short, significant innovation is required across four areas:

More innovation needed:

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Drawdown/distributions Under the n commitment model, cashflows are uncontrollable by investors. Commitments are for 10+ years, over which time a DC plan could change dramatically. Having no control over cashflows adds risk over and above illiquidity risk. We do not believe this is mitigated by the secondary market in Limited Partner (LP) positions. Therefore, DC requires a nimbler approach Defined Contribution Under the Microscope

with cashflows that are more certain and with managers who want to become long-term partners in their acquisition of assets.

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Fees A hot topic! The DWP is opining on whether performance fees/carried interest will be excluded from the charge cap, although issues such as intergenerational fairness will remain. Whilst illiquid assets are more expensive, the higher expected returns and scarcity are worth it. However, many fee structures in private markets are too high and the charge cap is a neat tool to use in manager negotiations to achieve a fairer balance.

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Diversity and market risk Equity risk dominates the growth stage of a DC saver’s portfolio, where private assets can fit best. Consequently, an illiquid allocation should be diverse,

provide access to different drivers of return, and allocate opportunistically across them, instead of investing solely in equity risk through asset classes like private equity.

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Complementarity to add value The higher governance burden and associated risks should be well rewarded through additional return, diversity, and sustainability characteristics. An illiquid portfolio should complement and augment a plan’s existing exposures. The LTAF structure presents a fantastic opportunity for the investment industry to provide DC savers with access to untapped asset classes and to help improve outcomes. We have designed an LTAF with the aim of delivering these benefits and addressing the challenges through an innovative approach.

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Guest View

James Lawrence Smart Pension “How we’re thinking about the opportunities and barriers in private markets”

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rivate markets bring about a significant number of opportunities for Defined Contribution (‘DC’) pension schemes in general, but there are still a number of barriers to getting there. As an asset class, private markets have traditionally been inaccessible to DC schemes, including master trusts, largely due to platform capabilities and cost. The tide is starting to turn on the first of these, though, with pressure across the industry, including from newer entrants to the market, to expand capabilities. However, there is still some way for the platform market to go before this becomes the norm. Cost does still remain a significant issue. Whilst the ‘land grab’ in the master trust arena, and subsequent race to the bottom on cost, is starting to plateau, price is still one of the biggest drivers in selecting a master trust, and therefore in how master trusts are designed. Unlocking member engagement At Smart Pension, we’re lucky that our purpose-built technology allows us more headroom to spend money on investments, which we believe will add significant value to members. Market pressure still restricts us (and others) from building investment portfolios that are optimal for members, though. Over time we do expect this to ease, as the pressure on value over cost continues and master trusts scale, but is likely to be a prolonged journey nonetheless. DC pension schemes in general, and particularly master trusts, have been scrambling to find ways of engaging members. The difficulty is that individuals find it difficult to plan for something which they perceive to be so far off. This is particularly true given the competing demands on someone’s time and money in the present day, and also the ever-changing political landscape, which always threatens to reduce the attraction of longterm saving. Our own research shows that the industry is failing in the most basic

Defined Contribution Under the Microscope

of tasks – helping individuals understand (a) that they have a pension, and (b) where that money goes once it’s taken out of their payslip at the end of the month. Over the past few years we’ve been constantly trialling new ways of engaging, through regular trials and pilots with members. One way that we’ve found of getting individuals to engage is giving them something tangible to hook onto, and get them to buy into a vision. For example, investing in affordable housing for society’s most vulnerable, funding new vaccine research or restoring wetlands are really tangible ways of showing members why pensions matter. Whilst those aren’t necessarily purely the remit of private markets – and we believe

Our own research shows that the industry is failing in the most basic of tasks that impact can be made through the public markets – private markets provide a significant opportunity to invest in these

opportunities and showcase real value creation, on top of driving member outcomes. We’ve found our allocation to private markets has been a great help in providing case studies for our members, showing them the true power of their money in funding great businesses. Looking ahead In summary, there are a significant number of opportunities for master trusts in private markets, but also a number of barriers which might stop us getting there. At Smart Pension, we’ll continue to chip away at those barriers so that we can engage members as we invest their savings, helping build a world they want to retire into and making sure they have enough money to do so.

An example communication we send our members to help them understand where their pension savings are invested

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Disclaimer

Disclaimer: Risk considerations While private assets investments offer potentially significant capital returns, funds and companies may face business and financial uncertainties. There can be no assurance that their use of the financing will be profitable to them or to any Fund. Investing in private asset funds and unlisted companies entails a higher risk than investing in companies listed on a recognised stock exchange or on other regulated markets. This is in particular because of the following major risk factors: Investment risk: private asset investments typically display uncertainties which do not exist to the same extent in other investments (e.g. listed securities). Private asset investments may be in entities which have only existed for a short time, which have little business experience, whose products do not have an established market, or which are faced with restructuring etc. Any forecast of future growth in value may therefore often be encumbered with greater uncertainties than is the case with many other investments. Capital loss risk: the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Market risk: market risk is the risk of investment losses due to negative effects of the capital markets on the overall performance of the fund. Credit risk: the fund will have an investor commitment/draw-down funding model which exposes the investment vehicle to the credit risk of its investors. If an investor fails to comply with a drawdown notice, the investment vehicle may be unable to pay its obligations when due. Liquidity risk: given the illiquid nature of private asset investments, investing in private assets are subject to asset liquidity risk. This liquidity risk is a result of the likelihood that a loss from current net asset value would be realised if an asset in the fund needed to be sold quickly in the secondary market to meet the obligations of the fund. Currency risk: investments in companies or instruments which are denominated in currencies other than the fund’s respective currency expose the fund to the risk of losses in case foreign currencies depreciate. Operational risk: operational risks are risks of loss resulting from inadequate or failed internal processes, people and systems, or from external events conducted by Schroder Adveq and the managers the fund will invest alongside.Valuation risk: it may be difficult to find appropriate pricing references in respect of unlisted investments. This difficulty may have an impact on the valuation of the portfolio of investments of a Sub-Fund. Certain investments are valued on the basis of estimated prices and therefore subject to potentially greater pricing uncertainties than listed securities. Impact Important Information. Marketing material for professional clients only. This is a concept proposal and relates to a potential investment fund which may or may not be launched. All terms described herein are indicative and subject to change. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall. Schroders has expressed its own views and opinions in this material presentation and these may change. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. Nothing in this material should be construed as advice or a recommendation to buy or sell. Information herein is believed to be reliable but we do not warrant its completeness or accuracy. Any data has been sourced by us and is provided without any warranties of any kind. It should be independently verified before further publication or use. Third party data is owned or licenced by the data provider and may not be reproduced, extracted or used for any other purpose without the data provider’s consent. Neither we, nor the data provider, will have any liability in connection with the third party data. The material is not intended to provide, and should not be relied on for accounting, legal or tax advice. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. No responsibility can be accepted for error of fact or opinion. The forecasts included in this presentation should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacypolicy or on request should you not have access to this webpage. For your security, communications may be recorded or monitored. Schroders Capital is the private markets division of Schroders. This information relates to a potential investment fund (the “Fund”) which may or may not be launched. All terms described herein are subject to change. Issued in July 2022 by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered in England, No. 4191730. Authorised and regulated by the Financial Conduct Authority. 605251.UK004613

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“DC innovation is moving forward apace. The aim: Driving enhanced and sustainable retirement outcomes for future generations"

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Defined Contribution Under the Microscope