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DC Innovation Unleashed: Optimising Outcomes for Generation DC

DC Innovation Unleashed

➡ Baillie Gifford Delivering sustainable income P24-25

➡ Berenberg Protected Equities P26-27 ➡ Guest View Aegon P28-29

Contents

➡ Focus on A sustainability focus can boost savers’ pots P30-32

➡ Ninety OneThe energy transition p34-35 ➡ Guest View Law Debenture P36-37

➡ Introduction P5 ➡ Insights from the audience P6-7 ➡ Focus on Setting the stage for innovation in DC P8-11

Focus on sustainability

➡ AB Unleashing innovation P12-13 ➡ Phoenix CIS: Platform innovation P14-15 ➡ Guest View Barnett Waddingham P16-17 ➡ Focus on Enhancing investment outcomes P18-22

Focus on collaboration

Focus on Innovation

DC Innovation Unleashed

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Meeting the diverse needs of scheme members today, requires a full understanding of Defined Contribution (DC) pensions including scheme demographics, member behaviour, regulatory policy, and capital markets. Our DC expertise and ongoing in-depth investment research underpin our flexible range of default investment solutions, all aimed at helping DC scheme members successfully transition from full-time employment to life after work. For more than fourteen years, we’ve been partnering with, and delivering, DC solutions to pension plans, master trusts and other pension providers in the UK. So, for an experienced, committed partner, come to AllianceBernstein - the home of DC solutions.

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, 60 London Wall, London EC2M 5SJ. 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. © 2023 AllianceBernstein L.P. ICMA2023384

Introduction

t’s often observed that innovation in defined contribution (DC) has been slow to arrive. In the autumn 2023 three-part Virtual Panel DC series, we wanted to take the market’s temperature on how well DC savers are being served. There’s good news to report: the tide is turning. Platforms, investment managers, consultants and the pension schemes they serve are collaborating in the name of better outcomes for savers. We explore how platforms are becoming enablers of innovation on p11. The industry is asking itself some important existential questions as it seeks to create a new and improved approach to DC. Is DC the best vehicle, or should the pendulum swing back towards greater stewardship of members’ assets, perhaps in the form of collective defined contribution (CDC)? The Virtual Panel’s audience is keeping an open mind – check out how many audience members were supportive of CDC on p6. How can we give DC savers access to the wide range of opportunities their defined benefit (DB) counterparts enjoy? Barnett Waddingham’s Hugo Gravell explores this on p16, as did our first panel on p8. How can we give DC retirees the income they need to last a lifetime? Baillie Gifford’s Lucie Majstrova discusses how today’s DC members can set themselves up for a sustainable long-term income in retirement on p24.

As pressure intensifies to reach net zero, how can DC schemes invest more sustainably? In this report, we explore the importance of emerging markets in the climate transition on p30. Law Debenture’s Natalie Winterfrost gives us a fascinating rationale as to why it’s time for pension schemes to move beyond TCFD reporting and look at the bigger picture on p36. The mood from the three sessions is cautiously optimistic. While DC innovation is overdue, it is here at last. The industry is proving unafraid to question current norms – and create better ones.

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

The mood from the three sessions is cautiously optimistic DC Innovation Unleashed

Setting the stage for innovation To frame the three-part Virtual Panel series, the audience were asked three key questions (see below). Most agreed that to and through retirement required the most innovation. A similar landslide felt that too much focus is placed on cost, rather than value. The majority were open to the idea of CDC.

Audience intelligence the Virtual Panel's audience's take on the DC issues of the day

Which part of the 'DC Ecosystem' requires most innovation? To & Thru retirement

15 Accessing Private Markets

9 Member engagement

6 Platforms / operational aspects

What is the biggest barrier to innovation in the UK DC market? Trustees and advisors being overwhelmed with conflicting priorities

3 Systems are unable to cope with increasing demands and complexity

4 Governmental aspects, e.g confusing/changing/messaging/regulation

7 Too much focus on cost rather than value

Do you support the introduction of Collective DC (CDC)

2 5 14

n Undecided n Yes n No n What is CDC?

DC Innovation Unleashed

Enhancing the core portfolio

Forging a sustainable path

Private markets is the area where most investment innovation is needed, felt most of the audience at the second event. We dived into why schemes are prioritising cost at the expense of value; most felt this was because of competitive pressure to race to the bottom on fees. The audience agreed that members' retirement journey needs more innovation.

Impact investment belongs in DC default funds, the vast majority of the audience believed at the third Virtual Panel event. Actively managed impact strategies are most likely to drive real world change, they believe. They were more divided about what's driving the debate on sustainability in DC: regulatory requirements, fiduciary duty or the need to deliver return.

Where is most innovation needed for DC investment?

What's MOST driving the debate on Sustainability in DC land?

Access to a wider palate of liquid investments

Regulatory requirements, now or incoming

5 More nimble tactical assest allocation in overall strategy

It's good fiduciary practice

Access to private markets

To deliver return

3 Members demand

Which part of the investment journey needs most innovation?

What's the optimal investment tool to drive real world change?

In retirement

Tilted passive indexes

11 The approaching retirement (end career life) stage

3 LTAF's or private climate solutions

11 The consolidating (mid career life) stage

4 Actively managed impact strategies

The high growth (early career life) stage

An increasing view is there is too much focus on cost and too little on value in investments, why is that? Member understanding

Lack of bandwidth or knowledge for trustees to consider different investments

Should impact investment belong:

Only in Self Select strategy

2 22

14 Competitive pressure to race to the bottom on fees

DC Innovation Unleashed

As part of default

DC 2.0: setting the stage for innovation in DC Building worldclass outcomes for Generation DC requires O collaboration between advisors, trusts and platforms

pening the first of a threepart series focusing on DC innovation, chair Matt Johnston observed that outstanding innovation has already been undertaken to deliver for generation DC. But there is much to do.

➡ Watch the round table recording 8

Value for money Although there is currently a large industry and governmental focus on private markets, it’s important not to forget that public markets will provide the biggest driver of member outcomes, said David Hutchins. “There’s no point in putting 10% in private markets if you don’t get the execution of the other 90% right.” Hutchins added: “Low cost access to public markets may come at a high price. We have seen an awful lot of people trying to manage their costs in public markets to get the sticker price DC Innovation Unleashed

Click the image to watch the webinar Top row: Matt Johnston, Philip Smith, Hugo Gravell Bottom row: Lydia Fearn, David Hutchins, Jess Williams

In Brief

There may be a lot of discussion about private markets at present, but it’s important to remember that public markets will continue to generate the bulk of investment returns for UK DC savers. Within private markets, investors should be highly selective about opportunities and remember the ultimate goal is to seek value offsetting for money at all times.

The perception of platforms is shifting, as a new generation of platforms seeks to work with the rest of the DC universe to enable, rather than constrain, DC innovation.

Collective DC (CDC) presents a real opportunity to improve outcomes for savers, as a halfway house between DC and DB. More discussion is needed to maximise benefits to employers and members.

DC Innovation Unleashed

down. People are more worried about cost than value for money. “We've seen low cost can come at a high price – whether it’s returns on stock lending which are disguised from the members, hidden execution costs, tax inefficient structures or lack of stewardship or ESG integration. The few basis points saved on the sticker price can add up to quite a large percentage loss in returns the returns you are getting from private assets.” Innovation in private markets Private markets are a hot topic which all schemes are talking about, said Lydia Fearn. “The challenge is trying to work out the right structure. Some of the larger schemes are looking at Long Term Asset Funds (LTAFs) and deciding if that is a feasible opportunity for them within their accumulation

The Panel

David Hutchins is a senior vice president and head of asset manager AB’s multi-asset solutions business, EMEA Lydia Fearn is a partner in the DC team at consultancy LCP Hugo Gravell is an investment consultant specialising in DC at Barnett Waddingham Philip Smith is DC director at master trust TPT Jess Willams head of corporate investment services, Phoenix Group

Source: AB

strategy and how that feeds through. Member fairness is a key point.” Despite today’s focus on this area, investing in private markets isn’t new for sophisticated DC investors, observed Hutchins. Choosing the right opportunity set should be the most important focus for DC fiduciaries. Hutchins explained: “Illiquid assets are just privately traded assets across equity, fixed income and property. There’s no difference to public markets from that perspective.” He advised: “People make all sorts of exaggerated claims about what [investing in private markets] does to risk-adjusted returns. Understand the economic drivers of the assets you want to invest in. Don’t be fooled by artificial smoothing and prices.” As ever, investors should seek to cut through the noise and maintain their focus on what will deliver the best outcomes for DC savers, Hutchins concluded. Hugo Gravell agreed with

Hutchins’ observations, adding: “From my perspective, what is really pleasing to see is across the master trust and own trust space, there is a really good appreciation of what matters most for members. Looking beyond just investment and just private markets to set priorities that are right for the scheme. That has led to a healthy dose of cynicism about the private markets space. If you look at modelling as to how much of an impact it will have on pot sizes for members – the government’s calculations assume big fee discounts, which we can’t rely on.” The best case for private markets is to be found in private credit, Hutchins proposed. “The data suggests there is an attractive additional yield here that is not replicable in public markets.” Private credit is generally floating rate rather than fixed term, he explained. It is a good fit for people who are approaching retirement and are looking for lower risk, yield-generating assets.

Platforms as enablers Historically, platforms have been seen as barriers to innovation, observed Jess Williams. “The way I see it is that we are there to be enablers, and a key part of the solution.” she said. “We ask how can we make change happen to deliver that?” A number of Phoenix CIS’ clients want to be able to embed ESG or impact within their investments, she added. The platform is trying to smooth their path. “We are putting the right contracts in place with all the underlying fund managers, ensuring that clients can access the funds and managers they want, and managing the transition for them.” Helping clients to access private markets is another focus for Williams and her team. But getting the right pricing information from fund managers is key to making this possible. “As a platform you are managing those positions from the liquid and illiquid side of the equation. We are doing that carefully.” To and through retirement is DC Innovation Unleashed

another item on Williams’ to do list. “We are working with asset managers, administrators and pension schemes to make sure that members have a smooth experience from the day they join the scheme all the way through to when they retire.” A new pathway to retirement Will CDC grow in popularity? David Hutchins hopes so. “Anything that can extend the journey into retirement longer for a member means you can take more investment risk which, over time, should generate better retirement outcomes.” TPT is actively considering its approach to CDC at the moment, Philip Smith reported. “We have third sector clients coming to us who have left defined benefit (DB) behind but are not seeing the DC member outcomes they would like and are seeing CDC as a possible solution. There is definitely a place for it, but it’s a wait and see.” Gravell believes there is a real opportunity in the UK to foster a best in class pensions system for decumulation – and CDC is only one of the options. "At Barnett Waddingham, we are excited by the potential for a more sophisticated approach to drawdown that has member engagement and flexibility at its core." There is a real opportunity for us to get together and push this forward. It is one of the few areas where we have an advantage compared to Australia. Australia just accrued assets, while members have been too nervous to take their money in retirement. The asset managers were happy, the members less so. In the UK, as assets grow from a smaller base, there is an opportunity for the industry to get together and solve this before it matters too much. However, as ever, the challenge is getting it right. As Smith observed: “Whether it’s commercially viable depends on whether the market will buy it. It isn’t a given that suddenly everyone who has spent significant money on DC master trusts is going to flip into CDC.” DC Innovation Unleashed

Partner Insight

Unleashing Innovation By David Hutchins, Senior Vice President, Head of AB’s multi-asset solutions business, EMEA

➡ Read More about AllianceBernstein 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. Past performance does not guarantee future results. Some of the principal risks of investing in Target Date Funds include: Market Risk: The market values of the Fund’s holdings rise and fall from day to day, so investments may lose value. Interest Rate Risk: Bonds may lose value if interest rates rise or fall—long-duration bonds tend to rise and fall more than shortduration bonds. Credit Risk: A bond’s credit rating reflects the issuer’s ability to make timely payments of interest or capital— the lower the rating, the higher the risk of default. If the issuer’s financial strength deteriorates, the issuer’s rating may be lowered and the bond’s value may decline. Allocation Risk: Allocating to different types of assets may have a large impact on returns if one of these asset classes significantly underperforms the others. Foreign Risk: Investing in non-UK assets may be more volatile because of political, regulatory, market and economic uncertainties associated with them. These risks are magnified in assets of emerging or developing markets. Currency Risk: If a non-UK asset’s trading currency weakens versus sterling, its value may be negatively affected when translated back into sterling terms. Reinsurance Risk: The underlying fund(s) is accessed via another insurance provider, also known as a reinsurance arrangement; creating a direct counterparty exposure. In the event of default by an insurance provider, the value of the assets will likely fall, which will be reflected in the value of our Fund price. Target Date Retirement Funds (TDFs) are designed for a typical pension fund saver intending to retire in or ar The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time. Important Information The views expressed herein may change at any time after the date of this publication. AllianceBernstein L.P. does not provide tax, legal or accounting advice. 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 information does not constitute investment advice and should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AB or its affiliates. AllianceBernstein L.P. makes no guarantees or representations as to, and shall have no liability for, any electronic content delivered by any third party, including, without limitation, the accuracy, subject matter, quality or timeliness of any electronic content. Note to Readers in the United Kingdom: Issued by AllianceBernstein Limited, 60 London Wall, London, EC2M 5SJ, registered in England, No. 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA). The [A/B] logo is a service mark of AllianceBernstein and AllianceBernstein® is a registered service mark used by permission of the owner, AllianceBernstein L.P. © 2023 AllianceBernstein L.P

erving Defined Contribution (DC) schemes with marketleading investment solutions and outstanding client support is a strategic priority for AllianceBernstein (AB) globally. Our flexible and proactively managed target date fund (TDF) solutions address the needs of DC members saving to and through retirement across the UK, the USA, and in parts of Asia. We launched our innovative TDF solutions in 2005, then in 2009 we established our first suite of UK TDFs for our own staff scheme. We manage £87 billion in DC client assets globally, as at 30 June 2023. Being at the cutting edge of innovation in DC pensions requires deep and ongoing research. That is what we’re committed to. Today we are proud to be delivering investment innovation for the DC default of our clients’ portfolios across ESG, illiquid assets, and decumulation. Innovating in Environmental, Social, and Governance (ESG): Material ESG considerations, including a deep understanding of climate change risk, are built into our DC investment solutions. We are focused on understanding and managing the financial risks and opportunities relating to ESG to help improve member outcomes. Since 2021 we have been building an allocation in a proprietary sleeve which, through sustainable investments, offers diversification to help enhance returns. We seek attractive characteristics in income (near-term cash flows), inflation (inflation linkages or sensitivity) and investment impact (deployment of capital to new sustainable projects). The allocation includes holdings in renewable energy infrastructure including wind, solar, and battery storage, and digital infrastructure that serves to connect and empower individuals and businesses. AB has been well prepared to deliver on the detailed ESG reporting that is now a standard requirement for DC schemes. Our client reports include ESG scores and ratings, and a range of carbon DC Innovation Unleashed

access), and selecting external manager strategies to implement for a pilot custom DC client. This project has strengthened our knowledge of DC best practice as it relates to investing in this asset class. This proprietary sleeve will be made available across our DC client base.

DC members need a seamless journey through accumulation and into retirement

metrics including those mandatory for Task Force on Climate-related Financial Disclosures (TCFD) reporting. AB has been intentional about ESG in our investment research and through the implementation of portfolio tilts and allocations in our TDFs since 2018. Since 2021 we have been building an allocation in a proprietary sleeve which, through sustainable investments, offers diversification to help enhance returns. We seek attractive characteristics in income (nearterm cash flows), inflation (inflation linkages or sensitivity) and investment impact (deployment of capital to new sustainable projects). The allocation includes holdings in renewable energy infrastructure including wind, solar, and battery storage, and digital infrastructure that serves to connect and empower individuals and businesses. AB has been well prepared to deliver on the detailed ESG reporting that is now a standard requirement for DC schemes. Our DC Innovation Unleashed

client reports include ESG scores and ratings, and a range of carbon metrics including those mandatory for Task Force on Climate-related Financial Disclosures (TCFD) reporting. Innovating in Illiquid Assets: Accessing illiquids is an important recurring challenge for DC schemes. We are committed to deepening the investment diversification of our TDFs to help further enhance returns through allocations to private markets. In 2021, we demonstrated that private equity exposure can be implemented in a UK DC solution via TDFs and in 2022 we increased that allocation in our clients’ portfolios. This allocation has been a significant contributor to our clients’ investment performance through 2023. We have conducted an extensive project on private credit for DC schemes aimed at: considering the benefits of a potential allocation, solving implementation hurdles (including pricing and platform

Innovating in Decumulation: Turning a DC savings pot into a reliable, sustainable income without sacrificing capital is now one of the industry’s biggest challenges, as early DC savers increasingly reach retirement. AB has innovated its TDFs to make the member’s journey as seamless as possible by providing a default to and through retirement. Based on our deep knowledge of DC we have created an institutionally priced drawdown product that combines our accumulation TDFs with our tried-and-tested retirement income TDFs, which launched in 2015. Our income-paying TDFs have delivered a high-and-rising level of income while maintaining capital values and preserving the option for DC members to annuitize on equivalent or improved terms. The resulting default solution, in line with the DWP’s call for a decumulation framework to support members at the point of access, is a Whole of Life fund range that enables a seamless default journey. This paves the way for AB to deliver a Collective Defined Contribution (CDC) proposition via TDFs for clients in-scheme and through partners. The CDC structure we have designed enables fair treatment between members from different socioeconomic groups and seeks to deliver value for money by optimizing outcomes, well within the charge cap. We remain committed strategically as a business globally to supporting DC schemes through innovation for better member outcomes.

Partner Insight

How platforms are innovating to support better DC outcomes Close collaboration will drive the innovation we D need to see

Operational challenges are the biggest barrier to

By Jess Williams, Head of Corporate Investment Services, Phoenix Group

➡ Read More about Phoenix CIS 14

C investment strategies are becoming ever more sophisticated, as schemes and their advisors strive for better outcomes for a generation that will increasingly rely on DC savings as their primary source of income in retirement. As an investment only platform, Phoenix CIS has a vital role to play in developing and implementing the solutions our clients need in order to deliver their evolving investment strategy. We can support trustees and advisors in a number of ways, helping to drive the innovation that will ultimately lead to better DC outcomes. Facilitating access to private markets Focus is rightly shifting from cost to value for DC savers, and schemes are increasingly looking to access private market assets to take advantage of the illiquidity premium which DB DC Innovation Unleashed

pricing cycles and have already launched a private equity solution on our platform that includes both liquid and illiquid components as part of a blended fund structure. This supports efficient cash flow and enables investment into illiquid assets at the appropriate trading points. The introduction of LTAFs will provide additional opportunities for DC schemes to invest in private markets. Trustees need to ensure they’re comfortable with the extended gating and notification periods, and we’re supporting our clients to understand these operational requirements. We’re also working with fund managers to launch LTAFs in response to client demand and are confident we can deliver what our clients will need, acting as an operational enabler to facilitate investment in alternative assets.

o private markets in DC - but platforms can help

schemes have long enjoyed. We recently conducted a poll which asked about the perceived barriers to private market investment within DC, and operational challenges came out on top. This is where platforms like ours can resolve some of the issues associated with investing in less liquid assets. We can adapt our processes to accommodate and manage funds that have non-standard dealing and

Platforms can smooth the journey towards sustainable investing DC Innovation Unleashed

Supporting schemes on their journey to net zero The same private market solutions that we’re enabling for DC schemes will also support them to meet their net zero commitments, through investment in areas such as sustainable infrastructure and alternative energy production. As a platform we can smooth the journey towards more sustainable investing, transitioning assets and managing operational complexities under the bonnet of a scheme’s white labelled and blended funds. Our scale enables us to offer attractive fund terms, alongside prefunding for transitional activity. We’re also rolling out a new type of report that explains the ESG characteristics of the funds scheme members invest in, using straightforward language and real-life comparisons. The report can be used by trustees and their advisors but will also be a useful tool to support member engagement and encourage more sustainable investment choices. Supporting effective scheme governance The evolving regulatory

environment has introduced new challenges for schemes and their advisors, as they navigate a raft of new reporting requirements. Phoenix CIS can offer solutions here too, as we work proactively on behalf of our clients to provide the necessary data, ensuring high levels of data coverage and presenting this back in a meaningful way. We’re likely to see further changes to scheme governance in future, and as a platform we’ll continue to access and develop appropriate data solutions to help our clients meet ongoing regulatory challenges. Delivering at- and post-retirement solutions The question of how DC savers will access an income in retirement is increasingly relevant, and one that Master Trusts are looking to provide answers for with innovative solutions to meet these needs. Working closely with our Master Trust clients, we’re seeing a wider range of products come to market, including flexible income drawdown options and annuities. Some Master Trusts are even developing to and through solutions to support in-scheme drawdown and facilitate a smooth transition for members moving into the decumulation phase. We will play a key role in implementing these solutions, providing flexibility, operational expertise and an understanding of the unique requirements of the schemes we work with. Embracing the challenges ahead As an industry, we’re pulling together to improve outcomes for current and future generations of DC savers, although it’s clear that we still have a long way to go. It’s this close collaboration that will drive the innovation we need to see, and while schemes and their advisors will be the architects of these solutions, it will be down to platforms like Phoenix CIS to build them on the solid foundations that ensure their success.

Guest View

Hugo Gravell FIA Barnett Waddingham “DC progress has been disappointing - but there's still hope"

➡ Read More about Barnett Waddingham For Professional Use only and should not be construed as advice

C members have been standing at the crossroads for too long. The pension freedoms announced in 2015 promised a utopia of flexibility, personalisation with bigger pensions. Yet nearly a decade later, the industry has collectively failed to develop the products and infrastructure that members need to truly engage with their retirement and prosper. And the problem is only growing: the cost-of-living crisis is leading more members to explore accessing their pension in-work and DC is becoming a larger share of pension savings for members reaching retirement. People are being left floundering as they try to navigate a list of acronyms and jargon (e.g. UFPLS!) that could give sustainable investment a run for its money, let alone make informed financial decisions on how to make their savings last deep into their retirement. The real challenge for trustees – both own trust and master trust – is deciding where to focus to have the biggest possible impact on the quality of their members’ retirement. And that’s no easy feat with announcements from DWP, HMT, TPR and the FCA, alongside a cascade of consultations covering VFM, CDC, trustee decision-making, consolidation, and plenty more besides (did I complain about acronyms?). But, while progress has been disappointing, I’m excited about the opportunity we all have to make a real difference. Here’s three big areas we’re discussing with our clients. Private markets After decades of ‘easy money’ the outlook for public and private markets is by no means clear cut. The global economy faces huge uncertainty – compounded by global warming affecting people and economies today – and diversification has never been more important. Diversifying across asset DC Innovation Unleashed

classes, geographies and across public and private markets is essential. The advent of Long-Term Asset Funds (LTAFs) offers potential for a step change in the take-up of private markets, although I’m still worried that commercial cost pressures will continue to hold DC providers back, despite many signing up to the Mansion House Compact. What’s more, despite the ambition of the Compact, the Government’s own calculation that private markets would benefit DC savers relies on significant fee discounts. Pension schemes face competition from a host of other investors in private markets, meaning those discounts may not be forthcoming – and the benefit to members left unclear. We’re excited to see innovation in this space, with plenty of LTAFs coming to market. The next phase of innovation will be a move away from multi-asset funds to more specialist mandates to reflect how the desired balance of risk and return evolves as members get older. For larger schemes, private credit and secured income offers real opportunities in the lead up to and through retirement, not just in the growth phase. By extending the amount of time members are invested in private markets and investing when pot sizes are larger, this innovation holds the key to ensuring the

benefits of private markets are really tangible for members. Managing risk in the consolidation phase In absolute terms, performance in 2022 was not good. The chart below shows at-retirement performance for a selection of DC master trust governed strategies. While improving annuity rates suggest members can still enjoy a similar quality of life in retirement, that won’t be the case for individuals who access a large part of their savings early on in their retirement. The lead up to retirement – that is, the consolidation phase – is a key area for innovation. Active management of credit holdings – ideally with flexibility to invest tactically across sectors and to reduce duration – is set to become a mainstay of DC strategies. Other options – like protected equity, which is discussed in this series – may offer potential where trustees are comfortable with more sophisticated approaches for their membership. In fact, many traditional investments underperform during sharp bouts of inflation, meaning sophisticated approaches may become a necessity if global inflation remains volatile during the transition to a greener economy and ongoing geopolitical tensions. There’s a key opportunity for

At retirement 1 Year performance to 31 December 2022 -17.2% -13.8%

-20%

-15%

-12.3% -11.8% -11.6% -11.0% -10.9% -10.3% -10.1% -10.1% -9.1% -8.3% -8.1% -8.1% -7.7% -7.3% -7.2% -6.09% -10%

-5%

Source: Barnett Waddingham, DC providers

DC Innovation Unleashed

own-trust schemes to stand out here, given the cost pressures facing DC providers. Interestingly, we are seeing more noise from providers around the potential to use tactical asset allocation – including actively managing the length of the glidepath. However, it remains to be seen how impactful this will be on financial outcomes given tight guidelines and being limited to existing building blocks, which makes it harder to manage financial risks like duration, which was the key contributor to poor at-retirement performance in 2022. It's all about member outcomes… Helping members make the most of their retirement is the topic trustees find more engaging than any other. We’ve seen more schemes innovate to help members stay in the institutional space when they retire – for instance, using retirement master trust bolt-ons to avoid sky-high retail charges and in some cases out-of-market risks and transaction costs. But there’s a lot more we can do. The technology and investment products members need to plan effectively for retirement and stay on track throughout do not exist. The new solutions coming to market don’t go far enough. Relying on a stable asset mix in the early years of retirement before taking an annuity is too simplistic. Most people are not financial experts and cannot understand the risks and trade-offs involved when deciding how much to drawdown each year. We believe there is a better way. The DC market is missing out on simple yet effective investments, like maturing bonds, that can offer more certainty to members and would be a natural fit for a retirement ecosystem that draws on the best thinking from investment, communications, financial planning, and user experience technologies. We believe this is the most exciting area of innovation for the DC market and are excited to be sharing more on this with the industry soon.

From Growth to Decumulation: Enhancing Investment Outcomes for Generation DC As DC investment D enters a more sophisticated era, how can schemes offer members a smoother journey ➡ Watch the round table recording 18

efined contribution (DC) investment is no longer a brave new world. After the dust settles after a turbulent bedding in period, new areas of focus are coming to light. To date, much of the attention has understandably been on the accumulation phase. Many DC savers are still young or in midcareer, and those retiring with DC pots today often still have the luxury of some defined benefit (DB) entitlement. In the future, that will change, with the next generations of retirees becoming wholly reliant on DC. A survey of the Virtual Panel’s audience indicated that investment innovation is most needed in the retirement space, both in the run-up and after savers have stopped working. But what do DC savers really need, and where should schemes focus their attention? DC Innovation Unleashed

Click the Image to watch the webinar Top row: Matt Johnston, Philipp Loehrhoff, Lucie Majstrova Bottom row: Michael Robinson, Jo Sharples

In Brief

DC investment is entering a new and more sophisticated phase, as DC schemes learn from the volatility of 2022 and respond to the evolving needs of DC savers.

Consolidation, decumulation and the retirement phase are specific areas where greater innovation is needed, according to the Virtual Panel’s audience.

Protection strategies will cushion DC savers from the worst of the volatility, while still allowing them upside in bull markets. Meanwhile, a focus on generating sustainable income will benefit DC savers during their retirement years.

DC Innovation Unleashed

The importance of protecting investors “Lessons are being learnt from 2022 about the perils of being too simplistic,” said Jo Sharples, chief investment officer of Aon’s DC solutions. Plain vanilla, passive equity strategies prevailed in the first iteration of DC investing, said Sharples. These days, investors are learning and becoming more sophisticated. “Clients want to get more out of their DC asset allocation and are willing to pay more for better value,” she observed. One salutary lesson from 2022 is that, in a rising interest rate environment, schemes may not have accounted for all their duration risk. There are simple actions schemes can take to mitigate that risk, said Sharples. She added: “Where schemes

The Panel

Philipp Loehrhoff is a portfolio manager at asset manager Berenberg Lucie Majstrova is a multi-asset and income product specialist at asset manager Baillie Gifford Michael Robinson is investment proposition manager at Aegon UK Jo Sharples is chief investment officer for Aon’s DC solutions

Portfolio positioning

Interest rates are likely to stay higher for longer, reducing the likelihood of a "soft landing" scenario. Recent interest rate hikes have dampened growth prospects DM Gov. Bonds 3%

Cash 3%

Equities 36% Focus on great income payers of tomorrow: companies with real income growth prospects

EM Local Currency 10% EM Hard Currency 8%

Fixed Income 38% Bonds are now providing high levels of income, reflecting concerns over high inflation.Opportunities across both developed and emerging markets

Investment Grade 6%

Equities 36%

Real Assets 22% Infrastructure investments include regulated utilities and renewable energy companies. Selective opportunities in Property, including in logistics, health care and digital infrastructure

High Yield 12% Infrastructure 14% Commodities 3%

Property 6%

A diversified multi-asset income seeking portfolio designed to provide inflation protected income

have used active strategies, you can see the value starting to come through. Schemes are staying well within the liquid asset space but are looking at slightly different strategies, such as asset backed securities. These will become increasingly important.” Michael Robinson, investment proposition manager at Aegon UK echoed Sharples’ points, adding: “A lot of members still have DB underpins so they are using their DC money as fun money for holidays and kitchens. We will see that change over time. We are still looking for the best possible outcomes, but low volatility will become more important to future savers. We are seeing a sea change in the market.” Protection strategies are increasingly available to DC savers to alleviate the risk of volatility throughout the saving journey. “Up until now, DC savers have only had access to very basic assets like passive equities and bonds, because lower fee levels in the DC

market have meant that managers have not been very keen to innovate,” explained Philipp Loehrhoff, a portfolio manager at Berenberg. This has impacted every stage of a saver’s journey. Throughout accumulation, often including pre-retirement, DC savers have often been invested in a high proportion of equities, with little downside protection, leading to volatile and uncertain outcomes. In the mid-stages, savers are often put into expensive diversified growth funds (DGFs), many of which have delivered disappointing performance over the last 15 years. In the later stages of their savings journey, preretirees are put into low volatility assets, which results in lower levels of growth. Loehrhoff observed: “When people enter retirement, life expectancy is 20 to 30 years on average. Given life expectancy is so long, it is a dilemma; they need growth assets, but they can’t take

too much risk. The problem gets worse in periods of high inflation. Inflation of eight percent or more is eating away at the purchasing power of their portfolios.” Thankfully, change is coming, with the advent of more sophisticated strategies. For instance, Berenberg’s strategy invests in ESG tilted global equities and uses options to reduce downside risk, while aiming to achieve attractive returns by participating in equity market upside. Investors may receive slightly lower upside in years where markets perform strongly, but they will be cushioned in bad years, leading to higher performance overall. Protected equities offer a higher predictability of outcomes and more stable investment returns, added Loehrhoff. Due to this type of fund’s characteristics, investors can stay invested in equities for longer, giving them the potential to achieve higher returns through the whole market cycle. DC Innovation Unleashed

Baillie Gifford Actual Income

We seek out growing, resilient companies because they can deliver growing, resilient income. Simple actually. Baillie Gifford’s income range: Global Income Growth; Strategic Bond Fund; High Yield Bond Fund and Sustainable Income Fund, believe that growing, resilient companies can deliver growing, resilient income too, not just high yields. So, we seek out these companies globally, to deliver the long-term returns our income investors are looking for. Actually, it’s as simple as that. As with any investment, your clients’ capital is at risk and income is not guaranteed. For financial advisors only, not retail investors. Find out more by watching our film at income.bailliegifford.com

Baillie Gifford & Co Limited is the Authorised Corporate Director of the Baillie Gifford ICVCs. Baillie Gifford & Co Limited is wholly owned by Baillie Gifford & Co. Both companies are authorised and regulated by the Financial Conduct Authority.

Source: Berenberg

A sustainable income in retirement Innovation is most needed in the late stages of saving and into decumulation, said the Virtual Panel’s audience. While annuity rates are much more attractive now, thanks to high interest rates, drawdown is still very popular with DC retirees, giving them extra flexibility about how and when they take their savings. This is where sustainable retirement income strategies can come in. Lucie Majstrova, multi-asset and investment specialist at Baillie Gifford said: “We carefully considered how to design the best possible strategy to give investors the income they can rely on that will grow in line with inflation but also leave them in charge of their capital.” What characterises a sustainable retirement income? First, it needs to be resilient, which means drawing from a diversified range of investments. Second, it must keep pace with the cost of living, which means it must be supported by capital that grows in line with

inflation. Third, it needs to be fit for the future, which means investing in companies today that will still be relevant in 20 or 30 years’ time. What could sit under the bonnet? Currently, Baillie Gifford’s portfolio is split approximately evenly between equities, real assets and fixed income. However, maintaining some flexibility is important, said Majstrova. She explained: “One of our portfolio managers is a former central banker – he predicted that inflation was likely to rise as a result of Covid-19 exit stimulus. We felt inflation would be persistent and higher than people expected. At that time, we had very little in government bonds and investment grade credit and used derivatives to further protect the portfolio from rising interest rates. “A quarter of the portfolio was in infrastructure, where we felt inflation-linked payments would support real income. We took inflation risk down through the

portfolio. This helped us get through the period and we have been adjusting throughout.” Within each asset class, Baillie Gifford assesses ESG suitability of every holding, and invests in their best income ideas specifically selected to meet the objectives of the strategy. To create sustainable income that will endure over the long term, Baillie Gifford steers clear of tobacco and oil companies. “We don’t want any ‘been and done’ players in the portfolio; we want to identify the best income players which will deliver over the long term,” said Majstrova. All companies in Baillie Gifford’s portfolio must be reliable dividend payers which offer dividend growth, she added. For example, one holding is L’Oreal, a beauty company which compounds its growth, year after year. Majstrova concluded: “It ultimately comes back to picking the right companies with the right ideas across a wide investment universe, with sustainable investment models.” DC Innovation Unleashed

Clarity. Institutional solutions to and through retirement.

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Partner Insight

Sustainable Income – Built to last How to give DC savers the income they need for a comfortable retirement By Lucie Majstrova, Investment specialist

➡ Read More about Baillie Gifford 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.

oday’s retirees need to set themselves up for the longterm. Indeed, women reaching the state retirement age this year can expect to spend over twenty years in retirement. What does it mean for Generation DC? How can you balance between drawing the highest possible income today without jeopardising your long-term plans? Our Sustainable Income portfolio was set up to answer this challenge. To us, sustainable income means an income that grows with inflation over time. We aim to produce that by investing globally across nine different asset classes, in companies and countries that we believe are adapting to the world’s challenges to be the best income payers of tomorrow. Income for the long haul How can we generate income that can be relied upon for decades? We believe focusing on long-term income growth is the answer. Investing in a variety of asset classes allows us to match their different characteristics so we can deliver a resilient income today and grow it over time. Thanks to increased interest rates, fixed income, in general, offers more attractive income levels. Our global reach allows us to look beyond traditional fixed income asset classes, benefiting from higher yields on offer. When it comes to stable, inflationmatching income growth, we look to real asset classes: infrastructure and property. Our infrastructure investments were very valuable last year, delivering diversification benefits at a time when both equities and fixed income struggled. The income resilience that is often coupled with contractual linkage to inflation is a great match for our objectives, so while we have taken some profit since last year, it remains a key part of our strategy. Last but not least, the engine of real income growth is equities. That is, if you pick the right ones. Long-term income, not short-term yield To fully reap the benefits of our DC Innovation Unleashed

Creating a sustainable income stream becomes more urgent as Generation DC starts to retire

broad opportunity set, we invest in a bespoke portfolio of hand-picked investments within each asset class. We test them for resilience and their potential to be the best income payers of tomorrow. When the objective is finding income that can last for decades, it’s crucial to think about an investment’s potential five or ten years from now. While that may sound obvious, fascination with yield leads many ‘income’ investors to focus on this year’s dividend and coupon payments. They often take on significant risks to both income and capital in the process. That’s why we focus on how a company’s dividend will progress over a longer period. Take the Danish pharmaceutical company Novo Nordisk, a holding since inception in August 2018. With a low current dividend yield, most income investors would give it a miss. However, since 2018 the company has grown its dividend by over 40 per cent and enjoyed significant capital growth – this is exactly the type of income investment we look out for. The trajectory of its dividend potential remains as exciting as ever, which is DC Innovation Unleashed

why it is still among our largest equity holdings. Fit for the future Sustainability has two meanings. Will an investment’s income stream prove to be sustainable over long periods of time? And is it sustainable from ESG perspective? We believe the two are inextricably linked. The best income payers of tomorrow will be forward-thinking companies that are successfully adapting to meet the needs of a sustainable economy. Can you build an income portfolio without the income investing classics such as oil and tobacco producers? We think you certainly can. Even more importantly, if you want a

The engine of real income growth is equities - if you pick the right ones

sustainable long-term income, we think that you should. In our view, increased regulatory scrutiny and transition costs make oil and tobacco unappealing investments, and we see better opportunities for income growth elsewhere. Our sustainability assessment is centred on a core question: is this investment compatible with a sustainable economy? We analyse all individual investments held in the Sustainable Income portfolio, from equities to emerging market bonds. While each asset class has its nuances, we take one consistent approach. Why accepting investment risk makes sense The need to create a sustainable retirement income stream becomes more urgent as Generation DC is entering decumulation. Income investing is about reducing inflation and sequencing risk, and retaining flexibility. We believe that our broad opportunity set, as well as the combination of skilful asset allocation and experience in stock picking, allows us to harness the best income payers of tomorrow to deliver real income, time after time.

Partner Insight

A solution for the decumulation challenge Why protected equities are a natural fit for DC members It's time to rethink traditional lifestyling

I By Philipp Loehrhoff

➡ Read More about Berenberg 26

n the UK’s DC market, the lifecycle model has always played a crucial role. This model dictates that the closer investors get to retirement, the more conservative their asset allocation becomes, typically shifting towards bonds and away from equities. Due to the generally young age of DC scheme members, the focus has been on the early stages of this journey, often with little regard to what comes next. Now with investment pots growing and members getting older, more assets are moving towards the later stages (mid-growth and decumulation) of the lifecycle which is causing fundamental changes within the DC market. In one sense the conservative DC Innovation Unleashed

approach in the later stages is a prudent one. Investors naturally become more risk-averse the closer they are to receiving their pension pot. However, looking at the broader picture across someone’s whole investment lifecycle and not just until retirement, this approach is too

Protected equities combine equity investments with a protective element DC Innovation Unleashed

conservative. What happens all too often is that these later stages of the lifecycle witness an overallocation to low-risk bonds and money market funds. This approach results in low equity allocations, which is problematic considering a retiree's remaining life expectancy has been steadily rising. Currently, a man aged 65 is expected to live for a further 20 years (for women this figure is even higher). This makes it even more important that pension funds should have higher growth asset exposure, given the high risk that conservative strategies will not give investors sufficient pension pots. In our new world of higher inflation, high bond allocations also pose a significant risk, as inflation could potentially erode the real value of the assets, particularly in the later stages of the lifecycle. This new market environment necessitates a focus on investments that generate positive real returns, another reason why investors later in the lifecycle should invest more in equities. One challenge here lies in the fact that many investors nearing retirement are unable or unwilling to take on the volatility associated with a more aggressive portfolio, necessitating a solution that balances risk and return. Up to now, not enough has been done to address this, especially as the number of DC members along with their pots keep growing and the age of the average member is increasing. To develop a solution to this problem, schemes need to understand that investors towards the end of the pension lifecycle want their investments to follow four key principles: n Risk Mitigation: Many DC investors want a solution that can provide a buffer against losses during market downturns. n Growth Potential: Although many DC investors are more defensive, they still want to participate in the growth of equity markets to ensure their savings last throughout retirement.

n Flexibility: There are broad

similarities between DC investors at this stage of the lifecycle, but schemes must be able to cater to various risk tolerances and investment horizons. n Inflation Protection: DC investors want their solutions to provide some form of protection against inflation. Unfortunately, there are not many solutions out there to address this challenge. However, recently some progress has been made and it comes from a familiar quarter. There’s a solution that has stood the test of time and that has become available to DC investors quite recently: Protected Equities. A Protected Equity strategy is an approach that has been used by many institutional investors over the last few decades. It works by combining equity investments with a protective element. The equity component gives investors growth potential and a hedge against inflation, while the protection component guards investors to some extent from the full brunt of potential losses during periods of market downturns. It offers investors in the mid-growth phase as well as those nearing retirement a way to maintain or even increase their equity exposure without increasing their risk profile substantially. If one wants to generate better returns without jeopardising savings, protected equity can provide the flexibility to achieve this. Our Protected Equity Strategy has only recently become accessible within the DC space in a way that fulfils the essential requirements for investors within the DC market by offering high liquidity and transparency, low cost, attractive value for money and ease of access via various platforms. It is also very complementary to other developments in the DC market such as private market investments and can offer a natural alternative to bonds and DGFs, many of which have often fallen short of expectations.

Guest View

Michael Robinson Aegon “A call for open mindedness in asset class allocation”

➡ Read More about Aegon 28

he DC market has been slow to innovate. Many in or near retirement have benefited from the security that having a DB underpin to their income provides. As a result, DC savings typically haven’t been used to provide a longterm stable income in retirement. As the membership of DB schemes reduce and generations continue to roll on, we are heading towards the first generation of DC savers who don’t have a DB safety net and the need for innovation will become more pronounced. As the ONS Wealth and Assets survey shows, pension pots form a large proportion of a household’s wealth and with many pension savers investing in their workplace default, providers have a key role to play in ensuring that savers are set up to make the best of their retirement. Traditionally, low-cost passive market cap solutions in DC have made up much of the market and have historically performed well. However, when compared to DB, there is a lack of diversification of asset classes that most have used for many years to drive growth and reduce risk, at price points that should be achievable given the DC industry’s scale. Looking beyond the traditional passive allocations, there are investment offerings available in the market that can be used to address the upcoming challenges facing UK savers. So, what else is out there? n There are asset classes where an active manager who deeply understands the asset class is needed to give the best possible outcome. Asset classes such as asset backed securities (ABSs), high yield and emerging market debt and certain equity markets could gain from active management to add benefits beyond what can be achieved through passive building blocks. It’s not that a fully active approach is the solution, however there is value to be generated from having a dedicated team who can actively manage the portfolio in the right areas. DC Innovation Unleashed

We are heading towards the first generation of DC savers who don't have a DB safety net

n With the Mansion House statement, and the government’s modelling suggesting that there’s a space for private markets in savers’ portfolios, private assets should be contemplated. What should be said however is that private markets should be allocated to with caution. Not all private assets are alike, and so within each private asset class providers should consider the particular type of asset, as well as the ability of the asset manager to source the correct deals. There are many operational and liquidity challenges and so any allocation should be done with the right level of due diligence and careful consideration prior to investing, as well as having an exit plan. Private markets won’t be a silver bullet, but providers should be ensuring that members benefit from DC Innovation Unleashed

long-term allocations both in accumulation and decumulation, whilst not paying this away in asset management fees. n Decumulation challenges can be nuanced and difficult, however a key point is that savings will need to last longer through periods of potentially high future inflation. So being invested in growth assets for the longer term may be seen as a positive for savers. Strategies which

The need for innovation is becoming more pronounced

allow savers to be diversified whilst still maintaining allocations to growth assets should be considered as the market moves into decumulation. Summary There will be a call for more innovation in the DC market as time progresses, but this doesn’t need to be overly complicated, so savers find it difficult to understand. Reviewing asset class allocations outside of passive building blocks should ensure that savers across accumulation and decumulation can trust their retirement assets are being looked after in the best possible way. For industry professionals only and shouldn’t be distributed to customers. Opinions are based on the outlook of the Aegon UK Investment Proposition team and shouldn’t be interpreted as recommendations or advice.

The growing DC consensus? That sustainability pays Investing in and engaging with heavy carbon emitters which are committed to change will help the transition – and boost DC savers’ pension pots ➡ Watch the round table recording 30

Today, 13 of the top 20 worst emissions offenders are in emerging markets. They account for over 60% of current emissions and are on a trajectory to represent 90% of emissions growth by 2030, according to data from active global investment manager Ninety One. Companies operating in developed markets have been able to focus their extensive resources on minimising their carbon emissions. This has not been the case in emerging markets, said Annika Brouwer, sustainability specialist at Ninety One. Brouwer explained: “Developed markets will be able to finance their own transition, whereas emerging markets won’t. There is a massive transition funding gap now – about $850bn per annum is needed. We know that 70% of current flows are philanthropic and development DC Innovation Unleashed

Click the image to watch the webinar Top row: Matt Johnston, Mark Thompson, Alison Leslie Bottom row: Annika Brouwer, Natalie Winterfrost

In brief

The worst carbon emitters are increasingly found in emerging markets. Instead of starving these sectors of capital, investors should seek to identify the companies which are committed to making a change – and support them as they grow.

Impact investing can be compatible with fiduciary duty, but as ever, investors should be selective about the opportunity set and do their due diligence.

Careful engagement with members focusing on sustainability and clear, enhanced reporting on how their pensions are invested for return, and good, could be a win-win for generation DC their interest could grow if the industry engages them with simple messages, and as TCFD reports evolve and become more multifaceted.

DC Innovation Unleashed

finance, aimed at financing smallscale projects in lower income countries. This will never be enough to reach the scale required. The focus has to be mobilising private finance to invest in commercially viable technologies to close the gap.” It is often held that pension schemes should divest from carbon offenders. However, turning away from the problem and starving companies of capital is not the solution. Instead, investing in the decarbonisation of the worst emitters should be a priority for DC investors, both to further sustainability goals and to achieve strong investment returns, said Brouwer. She explained: “Five key sectors emit 85% of the world’s emissions. Sectors like steel and cement have

The Panel

Annika Brouwer is a sustainability specialist at asset manager Ninety One Natalie Winterfrost is a director at independent trustee firm Law Debenture Mark Thompson is an experienced investment professional with expertise in both DC and DB pensions Alison Leslie is head of DC investment at Hymans Robertson

Source: Ninety One

high emissions, but these are sectors that will be needed for centuries to come. Right now, there is no alternative to cement or steel. We cannot exclude them from portfolios due to emissions alone. Investing in the decarbonisation of these sectors is a critical part of solving this problem.” Rather than divestment, Ninety One engages their high emitting companies to develop robust and mplementable transition plans to decarbonise their value chains. Adequate transition plans might mean the company is committed to net zero, has Scope 1, 2, and 3 targets, and have committed capital to achieving their goals. How will this help DC savers’ investment returns? Because innovators driving change from within traditional sectors will ultimately prosper. Brouwer used the example of Cemex. The cement industry is responsible for an incredible seven percent of global emissions. Last year, in a joint venture with Synhelion, they successfully produced solar clinker – the key component of cement – and made a significant step toward fully decarbonizing cement plants. Brouwer said: “We see that as a very strong indicator that this is the kind of company that is forward-looking. It is buffering itself against transition risk.”

Impact investing does align with fiduciary duty Instead of sitting on the sidelines in self-select funds, investors believe impact principles should be firmly embedded into DC default funds. Only by doing so can investors fulfil their fiduciary duty. “For me, incorporating ESG listed opportunities should be part of the main investment process. Impact is different. There are two types of impact investment: those that give you a good fiduciary return and those that don’t. Those that do form a much wider universe than many trustees currently think,” said DC investment expert Mark Thompson. “You can have impact investment and get a good fiduciary return – the two are not inconsistent.” Natalie Winterfrost echoed Thompson’s comments. “Considering sustainability has got

A successful business that finds a lower carbon alternative has got to be a good venture

to be integral to everything we do,” said the Law Debenture director. She added: “Doing the right thing for society can be aligned with getting a good return. The two are not mutually exclusive. For DC, we need to think in terms of longer term sustainability. Depletion of natural resources and global warming will have horrendous potential impacts on GDP and that will feed through into returns. We need to resolve these as part of our fiduciary responsibility.” Winterfrost finished: “It is about investing in commercial entities that have the capital to drive change. We know how much we need cement; we can’t put up wind turbines without it. We need an alternative. A successful business that finds an alternative with a lower carbon approach has got to be a good commercial venture.” Explaining it all to end investors The low readership of TCFD reports illustrates how little interest members have in the detail of what schemes are doing to address climate change. What will capture their imagination? Alison Leslie, head of DC investment at Hymans Robertson, said: “The level of detail found in TCFD reports isn’t important for members to understand. What is important for them to realise is that emerging markets are core to what we are trying to achieve in the climate space. Schemes should keep messages simple – ‘This is why we’re doing it’ – and use visuals to bring it to life.” Winterfrost added: “We must create a better and more multifaceted narrative in these reports. Ultimately, I would like my clients’ TCFD reports to become sustainability reports. I hope that one day some of my members do read it, or we can distil some key case studies from TCFD to members. There are members that are interested in these things. If it is a hook to get them to engage then great, otherwise we will have to continue to do what we believe is in members’ best interests, regardless.” DC Innovation Unleashed

In the race to net zero, we can’t run away from emerging markets.

Investing for a world of change

Finding ways to invest for impact and return.

www.ninetyone.com/transition Ninety One is authorised and regulated by the Financial Conduct Authority. Investments involve risk. Losses may be made.

Partner Insight

The building blocks of the energy transition and the important role of institutional capital

By Nazmeera Moola, Chief Sustainability Officer and Matt Christ, Portfolio Manager, Ninety One

➡ Learn more about transition investing 34

here will be no global net zero unless the energy transition in emerging markets is accelerated rapidly. That requires urgent action by long term pools of capital, with DC investors playing a critical role. Among developing nations, which now account for more than half of total emissions and rising, China alone has available resources to fund its energy transition. The rest of the developing world requires a massive increase in overseas investment. According to the International Energy Agency, roughly US$1 trillion of annual funding is required to decarbonise emerging economies (not including China). As of 2021, less than onesixth of that sum was being spent. Less than 1% of the institutional asset pool would be required to meet all of the developing world’s net-zero financing needs. The problem is not a shortage of capital per se. Global institutional assets, most of which are managed by pension and sovereign-wealth funds, add up to about US$120 trillion. Many allocators we speak to understand the ‘why’ but ask how assets can be mobilized to support the energy transition in emerging markets, while also contributing towards their return targets. The first step is for asset owners to recognise that in order to contribute meaningfully to lowering global emissions, they need to shift their allocations – and hence their influence – towards high-emitting companies, industries and countries. To date, too many have sought to clean up their portfolios by doing the opposite. This means allocating to the developing world especially. 13 of the 20 biggest carbon emitters are emerging economies. Large emitters among them include a diverse group classified by the OECD as middle-income countries, such as Brazil, China, Colombia, India, South Africa, Thailand and Turkey. Together, they account for 56% of the greenhouse gases put into the atmosphere each year. DC Innovation Unleashed

investing in companies. While many DC plans currently have an allocation to emerging markets via equities, very few invest in emerging credit. Yet this is a deep market, offering a highly efficient pathway to connect institutional asset pools with the businesses and projects at the heart of the emerging world’s energy transition. Moreover, by advancing climate-oriented covenants and embedding meaningful carrots and sticks in bond and loan documentation, investors can incentivise progress towards net zero in a targeted and effective way. Ninety One’s emerging markets corporate debt team alone manages investments in more than 40 countries – there are many private-and public-sector entities with serious net-zero intent seeking transition financing. The latter are often running well ahead of the former. In India, for example, whose national climate targets are generally seen as lagging, almost 100 companies have now adopted science-based emissionsreduction targets. In South Africa, Anglo American plans to install up to 4GW of renewable-energy capacity by 2040, which could see the mining giant generate about 7% of its home nation’s electricity needs.

DC investors must get to grips with transition investing in emerging markets

Ex-China, they still represent about one-quarter of global emissions. Most of them have fairly sophisticated private sectors and financial systems, offering a broad opportunity set and multiple access points for international capital. The second step, and perhaps the most important, is to dispel the myth that transition investing in emerging markets is a charitable undertaking. The ‘emerging transition’ investment universe is large and robust enough – and, crucially, generating sufficient economic value within individual DC Innovation Unleashed

nations – that it offers commercial returns. By sector, most of the transition investment in emerging countries needs to be directed towards building out renewableenergy generation capacity and upgrading the electricity grid. In our view, these and other transition-linked areas of emerging economies can be extremely competitive from a risk-return perspective. The third step is for long-term investors like DC plans to become more familiar with the most effective channels for transition investing in emerging markets:

In short, the building blocks exist to accelerate the emerging world’s energy transition: n the capital, via institutional asset pools; n the ambition, not least via emerging market companies’ transition plans; and n the mechanisms, of which the credit markets are arguably the most important. The urgent task now is to connect and action them, access the opportunity to derive long-term returns and real-world impact. This communication is for professional investors only.

Guest View

Natalie Winterfrost Law Debenture “Beyond TCFD: why it’s important to think about sustainability in the round”

➡ Read More about Law Debenture 36

ublishing Taskforce for ClimateRelated Financial Disclosures (TCFD) reports has been quite a learning curve over the last few years. On balance I am pleased that large schemes have been required to produce these reports, but there are pros and cons. One of the most obvious negatives is that the reporting requirements are extensive and prescriptive and making sure ‘every box is ticked’ in each year’s reporting can use up much time that might otherwise be spent furthering thinking on climate risk management and identifying opportunities. However, I think this negative has, at least to date, been outweighed by the impact it has had on pushing climate risk management up the pension scheme agenda. The compulsion to report on climate risk management has led to appropriate challenge of fund managers and changes to investment guidelines and benchmark both to manage climate risk and beyond. (Most of the boards I sit on thought about whether they should create a TCFD working group, but in the end plumped for an ESG committee.) Some things haven’t been working well with reporting. Data is a problem. We knew from the start data was going to be an issue, not least because pension funds were required to disclose data before anyone else in their investment chain was required to supply it. Reporting schemes have all created their ‘base data’ and yet it’s going to be far from perfect as a comparator for future years. Data on alternative asset classes is often missing or made up. Even though available, some consultants were very unwilling to include sovereign debt data in base data because they thought calculation methodologies might change. Methodologies in some areas have changed, making year to year comparisons apples versus pears, unless base data is subsequently revisited. I do feel though that two years on, scope 1 and 2 data (direct DC Innovation Unleashed

Let's move towards sustainability reports that cover social, nature and other ESG risks

greenhouse gas emissions and those from energy purchased) are getting much better. Scope 3 data (all the other greenhouse gas emissions throughout your supply chain) is another whole challenge. Scope 3 disclosures really are largely based on sector averages by company revenue. It doesn’t tell you much if anything at all about the risk management efforts of the companies you hold in your scheme, and it swamps scope 1 and 2. Another big problem in the preparation of our TCFD report is the scenario analysis. If this planet warms by three degrees beyond pre-industrial levels, we expect millions of people to be displaced and cities like Miami and Shanghai, as examples, to be claimed by the sea. Add to the displacement of some 18 million people extreme weather events that will threaten crops and that much of today’s agricultural land may be turned to desert anyway, it seems hard to envisage economic prosperity and stable DC Innovation Unleashed

geopolitics. And yet the ‘hothouse world’ scenario analysis carried out by consultants tells us our investment strategies will be resilient to such outcomes, shaving a couple of percentage, perhaps, off our funding levels. Hardly material. Regulators and policymakers are picking up on this and challenging us trustees to push back on our consultants. Many trustees, including myself, were doing this anyway but when the consultants were all using the same models and defending them robustly there isn’t really much a trustee can do (beyond caveating the findings in their reports). The other point worth making is that we cannot focus on greenhouse gas emissions in isolation. As stewards of capital, needing to ensure that there are investable assets able to deliver financial returns over the long term, we need to consider matters in the round. That includes other environmental and social factors.

The just transition is important we need to support emerging countries to transition whilst also recognising much of their population should be entitled to a higher living standard (which might come with increased emissions). We also need to recognise the importance of biodiversity and water. In some ways, the TCFD framework has overly concentrated trustee resources on just one aspect of sustainability at the expense of others. We have recently seen the publication of TNFD (the Taskforce for Nature-Related Financial Disclosures) and a consultation by the Social Factors Taskforce and this might address the balance, forcing trustee boards to think in the round. I for one want to move towards publishing a sustainability report for my pension funds that covers social, nature and other ESG risks. This would be consistent with the aims of the IFRS’ International Sustainability Standards Board.

DC Innovation Unleashed

DC innovation has been in short supply - but new developments in the market are creating a brighter future for the next generation of savers

DC Innovation Unleashed