Iain McGowan, Investments Director
We’re celebrating 15 years since we launched our Pension Investment Approaches (PIAs). Iain McGowan reflects on why the PIAs came into being and some of the key changes since launch.
This past decade and a half has certainly been eventful, beginning in the build up to a global financial crisis and ending with a global pandemic. Politics have been ever prominent, both in the UK and across the pond; Scottish independence out (for now) and Brexit in, while we’ve gone full circle from Democrat to Republican to Democrat in the US. The period has also been scarred by natural disasters, including the Haiti earthquake, the Japanese tsunami which led to the Fukushima nuclear disaster, and several huge hurricanes and tropical storms, together causing hundreds of billions of dollars in damage.
On a more positive note, we’ve seen the rise of global human rights movements, such as #MeToo and #BlackLivesMatter, while climate change has increasingly entered the public’s consciousness. In 2016, the historic Paris Climate Agreement was signed to take effective measures against climate damage.
Meanwhile, the rate of technological advances has been dizzying. Smartphones have become universal, as has social media. It is hard to believe that only 10 years ago Apple founder Steve Jobs unveiled the world's first iPad, and social media platforms such as Twitter, Instagram, LinkedIn and Snapchat were unknown.
It’s also been an incredible period for stock markets, helped by persistently low interest rates and led by US equities and, in particular, this new generation of tech companies. The combined market cap for just 5 of these stocks – Facebook, Apple, Amazon, Netflix and Google (known as the ‘FAANGS’) - is now more than the total GDP of many nations, including the UK.
We’ve not rested on our laurels either. Just as the markets have undergone significant changes over the period, we’ve been focused on evolving the PIAs and today they are Scottish Widows’ flagship investment options for workplace pension schemes and also the longest-running current default solution in the UK workplace pensions market.
15 years on, the PIAs have performed consistently well despite the vagaries of the market during this time. Pension Portfolio 2, for example (which is the initial fund used by Balanced customers), has returned 129% or 8.6% a year. Adjusted for inflation (CPI), this is a return of 108%. This compares to 82.9% (62.1% adjusted for CPI) over 10 years, or 6.2% a year, from the Mixed Investment 40% - 85% Shares ABI Sector.*
How have we delivered these returns? Casting my mind back 15 years, we recognised the need for a straightforward, low-cost, solution for workplace pension schemes. We also identified the importance of enabling members to de-risk their pension pots as they approached retirement, with the aim of reducing their exposure to any stock market dips at a time when any losses would be hard to make up.
The PIAs were thus born, offering three risk categories (Adventurous, Balanced and Cautious) and using four main funds (our Pension Portfolio Funds) to form the ‘bedrock’ of our ‘shop window’ workplace default. These funds are themselves invested in a range of underlying passively managed funds. We work with a range of fund managers and are not tied to any one investment house.
There’s now over £37bn in assets under management in the Pension Portfolio Funds so they benefit from economies of scale, enabling us to keep costs low for all customers. They are also subject to significant resource and oversight from the Group and are regularly scrutinised by our Independent Governance Committee, adding another layer of robust governance.
Arguably the most important ingredient – and one that has led to significant outperformance over the decade – is the active asset allocation approach of our dedicated in-house team of experts.
The Asset Allocation team plays a key role in the investment and governance process, regularly optimising the funds’ portfolios by selecting and weighting blends of asset classes to achieve investment goals. This is our focus because it is widely recognised that asset allocation has the biggest impact on long-term investment performance.
In trying to achieve the best returns for the appropriate level of risk, our modelling has directed us towards a higher exposure to equities during a significant part of the accumulation phase of a customer’s pension journey. However, this is offset by beginning to de-risk at an earlier stage than many other default solutions in the market. We aim to balance the benefits of de-risking towards retirement with maintaining the opportunity for investment growth that arises from equity investment. What this means is that our asset allocation and our glidepath are fully intertwined. They complement each other and are designed together with the aim of providing customers with as much money as possible for their retirement (given their risk parameters).
We always refrain from ‘tinkering’ around the edges and incurring the associated transaction costs with limited benefit, but have made some significant and meaningful changes to asset allocation within the PIAs over the past decade and a half that our modelling suggests will improve member outcomes.
Some of these have included reducing the investment in UK equities in 2014 and adding to overseas equities, as our modelling suggested that a more geographically diverse portfolio should deliver higher expected returns at a broadly similar level of risk. That year, we also introduced Emerging Market equities, with further allocation in 2015, reflecting our view that the long-term growth prospects for companies in the region were attractive and that their valuations were also appealing relative to companies in other parts of the world.
During 2017 and 2018, we gradually introduced global corporate bonds into the portfolios, at the expense of Index-Linked Gilts (ILGs), which we removed, and UK corporate bonds, which we reduced. We believed that global corporate bonds offered better risk-adjusted returns, particularly in relation to ILGs, which at the time were seeing negative real yields. Within the corporate bond allocation, the approximate split is now 50% overseas and 50% UK.
While 2020 has been very challenging, it has also been an exciting year for us as we introduced a number of enhancements to the PIAs. Specifically, we introduced a new asset allocation for equities, with a further reduction in “home bias” to the UK and aligning the split of investments in overseas equities closer to a market-capitalisation basis, from which we adjust our positions based on our long-term return assumptions for each region.
We also decided to diversify the PIAs into a wider range of asset types –without increasing charges to customers - notably adding Emerging Market Government Debt (EMGD) and Global Real Estate Investment Trusts (REITS). As well as offering diversification benefits, EMGD offers higher yields and potentially higher returns than its developed market equivalent. REITS also offer diversification benefits and reliable income.
Of all the enhancements we’ve made, however, the one which I believe will make us stand out from the crowd is our focus on Environmental, Social and Governance (ESG) considerations. We firmly believe that ignoring these factors will expose customers to unnecessary risk and deny them the opportunities that ESG investments afford. So we’ve taken a lead by integrating ESG considerations into the PIAs as we implement our wide-reaching Responsible Investment and Stewardship policies. By allocating an initial 10% of our equities exposure to a climate transition fund we designed with BlackRock, we’re backing businesses that are decreasing carbon emissions, increasing clean technology revenues and improving water and waste management. We expect to take further steps in this direction.
Exclusions are core to our responsible investment approach. So to end the decade, we’ve pledged to disinvest an initial £440m across Scottish Widows from companies that fail to meet our ESG standards. Their activities have such a negative impact on the planet and society that they pose an unacceptable investment risk. We’re working with our fund manager partners to apply exclusions to the underlying funds in the PIAs too.
What of the next 15 years? Well more of the same really. We’ll continue to make sure our PIAs are invested in what we believe to be the best underlying funds, consistently optimising asset allocation and making any changes we believe will deliver what we hope to be more stellar investment returns for your clients over the next decade and beyond.
Find out more about what the future may hold for multi-asset investing from Head of Pension Investments Maria Nazarova-Doyle, or read our 15 years of the Pension Investment Approaches Report.
* Performance quoted is for series 4, 06/12/2010 – 06/12/2020, net of fees, charged at 0.1% of total annual fund charge.
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