Nest wants to invest £1,500,000,000 into private markets, meaning just under 10% of our money will not be invested in public stock exchanges or debt markets but in companies that raise money other ways.
Actually £1.5bn is not a lot when it comes to buying the big household names like Morrisons, but this money is special, it is the savings of ordinary people many of whom will never have thought about what happens to their money once it is deducted from their pay. In one piece of internal research, Nest found that many of its customers thought their contributions bought them added state pension. This is not daft, Nest is owned by the state and has borrowed over £1bn from the taxpayer via loans from the DWP. Nest is super-accountable for its actions because it is the Government’s own workplace pension.
There is much we don’t know (yet) about Nest’s intentions. But it is clear that it has the scale to do what other workplace pensions can do later. The first question we should be asking of Nest is
Will Nest work with competitors to achieve an investment big bang?
The money Nest and other large pension schemes bring to the private markets is “sticky”. It is patient capital that doesn’t need to be withdrawn. Claims on Nest’s fund need not come out of this part of its investment strategy, the money is “patient capital”. Companies and projects that receive money from Nest – either as loans or as an equity purchase, can develop secure they will not be called to return that money imminently.
The responsibility for where the money is invested , rests with Nest who have employed specialists to make those decisions. The resource that Nest has at its disposal should be able to identify opportunities that in sum require much more than £1.5bn in funding. Inevitably , Nest will need co-investors. It can leave the pooling of the investment to private equity funds or organize the pooling itself. We have seen in the past, pension funds collaborating in the private markets, most notably in the local Government space, will Nest find ways to do the same or will it either rely on existing pools or go it alone?
Will Nest seed Long Term Asset Funds?
The Government has been working with the Investment Association and is expected to announce a new kind of investment vehicle, that will not need the insurance wrapper that most workplace pensions use, and will be able to invest in different kinds of assets with the emphasis being on the “long term”.
These funds need “seeding”. That’s the technical term for an initial investment which get the fund to a size where further investments can follow, either from the Seeder or from others. It seems consistent with Government policy that the Government’s pension should pioneer the use of LTAFs. Again the question is whether these funds will be managed by Nest or outsourced to traditional managers of private equity and debt.
Will Nest challenge the “carry”.
Most people I know who work in private markets tell me (in private) that the charging structures employed by private equity funds are unnecessary complex and overly expensive. They are aligned with the needs of other investors who are looking for a steady return and where investors are prepared to sacrifice growth for stability. This is why DB funds love private equity and why the Pensions Regulator is nervous about allowing DB funds to over commit to investments which look good on the balance sheet but which are sub-optimal in funding long-term liabilities.
The chief worry is that performance fees (the carry), are being charged as part of a Faustian pact , between sponsors, trustees and private equity funds, leaking huge amounts of returns into the hands of the fund managers in exchange for balance sheet protection for sponsors and a quiet life for trustees. This kind of nonsense has no place in a DC workplace pension (as Chris Sier has pointed out to me on several occasions).
Nest has the clout, especially if it works with other workplace pensions , to challenge the conventional way the Private Equity managers declare returns and make their charges. We need a more open system both of valuing the assets and paying the fees. Current charging structures that involve a percentage of the growth in the fund being paid to the manager seem unnecessarily generous and intrinsically opaque.
Will Nest explain where the money is going?
To date, Nest has been far from clear about the details of its investments. We don’t know how much it is paying for asset management nor what specific investments it is making (outside the passive core of the fund).
Nest has a large investment team that is well enough funded to explain what it is doing to a market that wants to hear. In many ways, we are hearing too much about Sidecars and other engagement tools and not enough about where our money is going ( I count myself a Nest investor).
The Government wants an investment big bang that will reinvigorate Britain after the shock of the last 18 months. It is also looking for pension funds to provide stewardship to the owners of companies and assets so that those assets are managed on an environmentally sustainable way with strong internal governance. These aims (collectively known as ESG) can be achieved – but we need to see ESG in action.
Nest needs to be clear about what is happening to our money. I suggest that this will be best achieved by reducing the level of intermediation to a minimum and that Nest, as far as possible , manages investments itself.
To do this, it should be looking to work with other large funds such as People’s Pension, Now, Smart and others. It should also be working with the DB consolidators, who have long time horizons and the same aspirations with regards accessing private markets.
Making our money matter
The sums involved even today – but especially tomorrow – are staggering. Nest expects to have £80bn available for investment by the mid 2040s and if DC consolidation continues at the current pace, Nest may not be the biggest master trust. Indeed we may DB consolidators such as SuperFund, surpassing Nest as they bring economies of scale to bear on smaller schemes.
We need not sacrifice competition by urging these huge funds to work together. Success for one will mean success for many.
If we are to see pensions make a difference, they need to be seen as the generators of positive change and I think that Nest and others can do this , if they are open in their dealings , collaborative in their approach and if they challenge the existing hegemony of the Private Equity markets.
If people can see their pension funds working for common good, they may pay more attention to the purpose of those funds, to deliver them proper pensions. This is the very positive potential that Nest has – I hope it meets the challenges its scale, and our money, offers it.
Changing how private equity currently works
For a simple explanation of how private equity funds works, watch this video (note – some of the references are to American regulations).
This model looks too complex and opaque to make sense to Nest investors. My hope is that wherever our money ends up, we can look through the fund structure and see what is going on.