A roadmap to a resilient retirement

Seun Fayoyin

Welcome back to the PensionShip podcast, our podcast series from BlackRock for professional investors here in the UK. I’m your host Sean Fayoyin. And in this series we’ll be sharing some more expert insights and opinions on the key trends shaping the UK retirement market. In today’s episode will be turning our attention to fixed income, which is playing a really critical role in UK client portfolios.

However, with increased uncertainty as a result of several different competing macro and geopolitical forces, which is leading to increased market volatility, the future path of interest rates remains uncertain and this has a natural impact on the fixed income investors. And so joining me today to discuss this topic are two senior strategists from BlackRock. We have Eric Rosado, senior strategist within the fundamental fixed income business, and Samuel Wellock, a senior LDI client, portfolio manager within the EMEA, LDI business.

Eric and Sam, it is great to have you on the show. Welcome to you both.

Eric Rosado

I’m excited to be here.

Sam Wellock

Me too.

Seun Fayoyin

Fantastic. So like I mentioned on the outset, fixed income is playing a more important part in client portfolios and I’m sure you’ll agree, but it’s been a bumpy ride, hasn’t it? After a decade of low growth, low rates and yields. Fixed income seems to be bouncing back into the spotlight. And so perhaps to start us off.

Can you sort of provide some context and frame sort of the current fixed income landscape as you see today? I think I’m going to come to you.

Eric Rosado

I think prior to jumping into the current fixed income backdrop, it is worth spending a moment just recapping how we’ve gotten to the place we have today within the fixed income market. So over 2022 and from much of 2023 global central banks in an effort to combat high levels of inflation delivered consecutive interest rate hikes.

The pace and the rate of these hikes were both unprecedented in nature and as an example, the bank rate in the UK went from ten basis points at the end of 2021 to 3 and a half percent at the end of 2022, and today currently sits at a rate of 5%, which is where we stand today.¹

So a significant historic move in interest rates, which again, ultimately if we think about the role in fixed income today being yield, your starting point looks very, very compelling.

And I think we’ll sort of diagnose and dig into the path for central banks moving forward. But I think could say that they’re largely adopting a data dependent approach moving forward. So, looking at specific measures of inflation within goods and services to determine the path policy moving forward. And I think what does that mean for us today?

It effectively means that when you look across the fixed income landscape to government bonds, credit other asset class, other sectors like securitized assets, the overall yield that you’re getting compensated for in fixed income looks incredibly compelling one. And as I think as our clients think about income as an outcome that we can construct, that income portfolio looks really interesting.

And I think there are probably three things that make the current environment unique to the fixed income landscape. So the first is that you can develop, you can essentially construct a real well-diversified portfolio that is high quality nature. And I think we define high quality in different regards. But when we talk about high quality, we talk about investment grade credit, so very high quality companies.

The second element around this is that when we think about where the most attractive opportunity lies within fixed income markets, thinking about a yield curve, large majority of that resides in the front end of the yield curve. So you can take you can construct a portfolio of high quality companies that are maturing in very short order. Overall level of interest rate duration are taking is low.

And then finally, you can essentially do that in a manner that is as global. So you can construct a portfolio of, you know, U.S., UK, European companies all in effort. And I think when you combine those elements together, I think it makes it a very compelling backdrop for fixed income. Yeah, I think that totally makes sense, particularly around that point around, you know, some of the central bank decisions being very sort of data dependent.

Seun

And the three points that you’ve just highlighted in terms of, you know, the unique opportunities here that we’re seeing within the market definitely resonates. Any other thoughts that you’d like to add to this?

Sam

Yeah, I guess I want to kind of counter some of the points that as well a little bit is just if we think about kind of fiscal position of a number of governments post COVID and also post the kind of cost of living crisis where we saw that kind of rapid increase in inflation.

And as a result, a number of things like public sector pay, settlements, etc., coming through means that a lot of those countries now face a pretty significant fiscal headwind. So, you know, record amounts of issuance and supply coming through, whether that’s through net issuance to finance the fiscal position or whether that’s through things like quantitative tightening. So I think there is some aspects there that become a consideration, particularly when you think about things like issuance in some regions where they’re seeing political change.

So we want to watch, particularly as we go through the next kind of 12 months where we’ve seen a huge amount of political instability coming through.

Seun

Yeah, that’s super interesting, Eric. Coming back to you, I think the markets have evolved quite significantly over the past recent years. How do you think the role of fixed income has also evolved and what do you hear from clients?

Eric

So I don’t think the core tenants of fixed income have changed in recent years. I think the asset class has always been thought of by investors as an area where you can achieve capital preservation, income and total return, I think, when thinking about those particular outcomes. So I think historically investors had to be quite careful and deliberate on how they would look to solve for those specific outcomes.

So as an example, prior to 2022, an investor is looking to solve for something like income, maybe had to move further down credit quality spectrum, invest in a broader opportunity set that would include things like emerging markets or ultimately invest in a solution that was designed to take a more tech sector approach to selecting specific income opportunities from a risk adjusted perspective.

I think that’s really in stark contrast to what we see today. We’re given higher overall yields in fixed income markets. As we’ve talked about previously. You can actually solve for the same income outcome by taking structurally less risk and through specifically investment grade corporate bonds. An additional reframing we’ve seen, I think within the fixed income market is around capital preservation.

So historically we’ve thought of government bonds as safe haven assets and indeed they are in circumstances where if there is a risk assets sell off the relationship between risk and risk free assets, i.e. government bonds are one that is inverse. However, we think this correlation has broken down in recent times. If we think about and if we think about 2022 and into 2023 as central banks raised interest rates, the mark to market prices on government bonds fell.

And so as a byproduct of that, when you’re thinking about something like capital preservation, I think DB DC schemes have to rethink about how they look to solve for that particular outcome. And one solution to that is to be delivered, but about how much duration you own within a portfolio and structurally where you run that duration. So if we’re thinking about ways to structurally limit the amount of duration or interest rate sensitivity you’re taking within a portfolio, investing in corporate bonds, let’s say they’re maturing in 0 to 5 years, exposure to structure, less interest rates than, let’s say, something that is maturing at 7 to 15 years.

So tying this ultimately back to the role fixed income can play in a portfolio, if you’re looking to solve for something like capital preservation, owning front end short dated credit is a way to solve for this. And ultimately, if we think about opportunities within the fixed income landscape today, if you’re just solving for returns, we think you’re essentially not compensated appropriately to own interest rates further out the curve.

And I guess that leads us to our other point, which is when we think specifically about opportunities within the fixed income market, we generally see investment grade credit as a as an attractive proposition. And when thinking about the attractiveness of an asset class, we generally think about it through three lenses. So the underlying health of that market or the fundamental backdrop, the attractiveness or expansiveness of the market, we think about that from as valuations and finally essentially the technical backdrop.

So the supply and demand for the underlying market. In summary, we think that companies are actually, you know, in a relatively good place. We see earnings, we see top line growth being fairly resilient and better than expected in some areas of the corporate bond market. however, we are cognizant of the fact that higher interest rates, higher inflation and perhaps maybe a more challenged economic backdrop can have a potential impact on company profitability.

We don’t think that’s widespread across the sector, but certainly thinking about more cyclicality, this is something that we are quite cognizant of. So expect divergent performance across sectors. in addition to that, if we think about the starting point for investment grade credit from a valuation perspective, whilst spreads, so this is the compensation you receive above a government bond yield widely known as the credit risk premia, while spreads look fairly expensive historically, Ultimately when you pair that with the all in yields received on corporate bonds, they still look very, very attractive.

Which brings me to my final point around the attractiveness of the asset class, which is the technical backdrop. We’ve seen a lot of demand for investment grade credit coming from investors who are effectively looking to lock in high levels of yield. And I think that is obviously something that we have highlighted and will continue to highlight throughout this podcast is that when you’re looking to build income portfolios, IG remains an area of the market that looks quite compelling.

Seun

And Eric Yes, I agree with everything you just said, actually, particularly when we think about some of the clients that I speak to that focus on investment grade credit actually resonates quite highly with a focus on high quality investment grade and income to be able to give balance within client portfolios. But also there’s the topic of sustainability, right?

That comes up in all the conversations that I have. I mean, what are your thoughts on that?

Eric

Yeah, it’s a great question. And frankly, it’s something that we’re effectively embedded within our investment process. How we think about a company today, how they think about addressing transition and commitments that they’re making towards meeting. For example, net zero ambition is fundamental in how we think about selecting an issuer.

So as an example, in carbon intensive sectors, we often think about companies who perhaps have a really strong emissions profile and have a track record of reducing emissions over time. But equally and more importantly, if they have plans to continue to reduce emissions in the future. So it’s integral in how we think about underlying credit selection. And I think over time, what you’ll find is that your ESG risk will just basically become a risk within a company’s profile

Seun

And so thinking about the clients that we serve in the UK retirement landscape and focusing on DB clients, when we reflect to the journey that DP schemes have been on in recent years, I believe there’s now a lot of discussion around and game planning with many schemes now in a better funded position relative to expectations. How essential is fixed income to end game solutions?

Sam

Well, I think it’s become front and centre. I mean, if we think about the history of DB schemes over the last three or four years, we’ve gone from position really driven by the fact that real yields have increased considerably where we’re now seeing record levels of funding. That’s obviously impacted by the impacts of real yields, but also shown performance underlying growth assets.

Now some of the aspects that I think are really coming through as part of that are really how schemes think about that end game. Now there’s kind of two, I’d say, predominant conversations that schemes are having, whether that’s to look to run on the scheme indefinitely for over a period of time or look to actually transfer that risk to insurance companies.

So do a pension transfer activity, a buy in, buy out. Now one of the things that’s put a bit of a spanner in the works is, is the announcement around the Mansion House reforms where we’ve seen a number of changes and policy changes which allow more flexibility of schemes moving forward, particularly when it comes to things like rental and how they can look to maybe access surplus going forward.

So many resources to consider that approach where that’s something that they want to think about rather than getting to the traditional routes of, of going to an insurance company for that risk transfer rates. Now, I think regardless of where schemes choose in that path, or through an insurance company or whether that’s going through to run on fixed income becomes an increasingly important component of that.

Now we think about the key aspects of that. If schemes are thinking to run on and they want to a low risk portfolio that’s built around delivering cash flows to meet member payments, but also one that helps ensure that scheme funding is relatively stable. So if we think about that, assets matching liabilities, a fixed income is a key component of that.

Secondly, actually, if schemes are thinking to go to something like risk transfer as an alternative route, then actually what they’re also doing is looking to want to build a portfolio that looks similar to that of an insurance company. So if you think about what insurance companies invest in, they typically have large allocations to fixed income, predominantly investment grade credits.

And as a result, we see more and more schemes look at as they go towards an insurance transaction, allocating more to things like investment grade, high quality credits that really underpins that and provides a kind of proxy for that insurance pricing. So really kind of both routes, whether it’s kind of run on or looking to go to risk transfer, require a pretty large allocation of fixed income.

I think that’s going to be increasingly important components. Now we’ve written a couple of pieces on this recently. We wrote recently a White paper which looked at running on and it’s called Keep the Plan. And we’re also writing other pieces as well as to how schemes can look at extracting that investment grade credit. But with the most efficient yields.

Sam

So we wrote a recent version of the ideas piece which looks at how you can purchase credit, particularly longer duration credits using LDI and integrating a single portfolio to make sure you pick up that yield, which gives you some attractive returns going forward. Yeah, no, thanks for that. So I think it’s pleasing to hear that investors have several different options as they think about their end game paths.

Seun

But it does feel like regardless of what options or what parts they decide to go with, there’s definitely a role for fixed income. But what about active fixed income as well? Do you think that there’s a role for that within such type of portfolios? 100%. And you know, I listen to a lot of the points that Sam has raised around essentially the asset liability management, around schemes, around the preference for, you know, building a cash flow profile.

Eric

And so I think when we think about schemes in this stage, it requires a high degree of customization, of course, a high degree of understanding requirement, effectively modelling around that solution. So if I think about the active management solutions that we have within fixed income, we’re very much tailoring to those specific outcomes. So I think active managers as a way to solve for an outcome.

There’s certainly a lot of merit to having an active manager essentially construct that portfolio for you. And then we were talking a little bit earlier about outcomes, specifically things like capital preservation, income. I think those are very much ring true for active managers as well. We can define capital preservation and a lot of different ways, but I think one primary way to think about it is how you manage credit deterioration over time.

So having an active manager have a process around the selection of an underlying company and also the management through that, through owning that bond, in an instance where, for example, risks begin to rise, there’s value for not diminished in preserving capital for client, likewise for income. As we all know, there’s been a very large move in yields over the last several years.

We’re actually seeing a lot of dispersion across various corporate bond sectors. So there’s certainly going to be opportunity for an active manager to pick winners and losers in the market over time. We’re talking a lot about central banks. We haven’t talked a lot about economic growth, but certainly we have a view that economic growth is going to slow down over time.

Thinking about what areas of the market that you own that are maybe a bit more defensive in nature, in line with that capital preservation or that income outcome becomes quite important. And I think ultimately there are specific areas where there are going to be inefficiencies within fixed income markets that active managers can ultimately look to exploit to perform or outperform a broader market.

Seun

Yeah. And so, Sam, sticking with the theme of end games, how have LDI Strategies evolved to support clients end game ambitions? It’s a really good question. So I think there’s a few things that particularly off the back of the kind of volatility that we’ve seen over the last couple of years. So one, I’d say key theme has been moving clients, moving away from this discrete hedging mandates or having one objective of marginal rates in inflation to actually a portfolio that looks to have a number of objectives that multifaceted.

Sam

So for example, having a risk objective and looks to manage hedging, but also things like default and downgrade, that’s really important in an investment grade by maintaining portfolio, but also then thinking about actually how you can generate some return. So what can you generate above gilts to earn that long term return that you need for whichever end game you choose, but also then thinking about cash flow, how can you ensure that your underlying pension is that you’re paying out?

And the memory requirements for a country perspective are met through your portfolio? So we’ve been seeing an increasing number of what we call integrated mandates, where you see those three components brought into a single portfolio. Now the other aspect of that I think is really important is that simplification of governance. So in an integrated fashion, what you see a simplification of is that governance framework that you have when you have things like increases in rates, which mean that you need additional class within LDI.

And what that has led to is typically things like LDI and investment grade Credit in the same place, but also the adoption of much more wider adoption of cluster waterfalls. So having assets that you can look to generate additional collateral if you need to within a relatively short period of time. So it could be something like shorter duration credit, it could be an ETF, for example, those types of different solutions available.

And then finally, I think one of the important things, though as well is that simplification of governance. So, you know, really we’ve seen this trend of schemes look to you for the fixed income allocation use one manager rather than multiple. And that really allows you to simplify that governance process. So when you face a class or call, for example, from let’s say an increase in rates, actually what you can do is that manager can manage that governance process for you rather than having to make a number of decisions that take a lot.

It’s a long time in that process, particularly for rates. So that’s something we think is really important. Finally, I’d say as well, the big focus around cluster resiliency. So two areas that are important. One is how you think about calculating, calculating collateral and post the gilt crisis has been lots of talk of how regulators apply that framework.

Obviously making sure you’ve got the right approach to manage that at the manager, but also how you can then utilize new tools, additional eligible class. Also, one of the things that we’ve been working on is utilizing credit classifier as we approach the new tool to turn segregated investment grade credits into eligible collateral to post against gilt repo transactions.

It helps you improve resilience, but also add flexibility in terms of managing that portfolio going forward. I think those are really the kind of key aspects I probably touch on from the integration perspective. Yeah, that makes sense. And that integration actually just when you were speaking about it, it makes me think about simplicity. Exactly. And just making that governance framework a lot more and less bothersome for clients, isn’t it?

Seun

Yeah, exactly. It’s right. Excellent. So we’ve spoken a lot about the retirement landscape from the lens of a DB investors, but as the landscape evolves, there is also a focus on DC schemes. And so how important is fixed income to DC clients and what role does this play within the space?

Sam

Yeah, so I guess with what we’ve seen in the last couple of years is DC becoming a much larger component of the pensions framework, So that’s given us significant growth and the accumulation phase is really starting to see to get some wind behind it.

And I think the one aspect that’s important there is as we as DC matures, you’re going to face more and more schemes looking to approach that pre-retirement phase or actually in some cases the accumulation. And as part of that, you know, fixed income is likely to form a strong component given it retirement solutions will require some income, but also pre-retirement will want to ensure that as you approach that retirement age, you have more certainty over what your income in retirement is going to be.

So making sure that your pot is less, let’s say, variable or sensitive to economic conditions. And it was maybe at the early stage of that accumulation phase. So I think is part of the industry evolves. We’re going to see far more use of fixed income as part of that pre-retirement and accumulation phase and how we think about them broadly.

Eric

So I think we’ve been seeing lots of clients look at those different areas and we’re seeing more importance, particularly looking at things like how you can think about inflation, how you can think about protecting against some of these move things moving forward. Yeah. that makes sense. Eric, any final thoughts to add? No, I mean, I would completely agree.

I think there are parallels to draw between how you think about the core outcomes and fixed income between DB and DC schemes, as Sam has highlighted. So I think the role in fixed income should very much feel similar when you think about those two specific retirement plan.

Seun

Fantastic.

Well, thank you, Eric, and thank you, Sam, for joining the podcast today. We hope to have you back at a future session and thank you to our listeners for listening and join us again sometime when we continue to discuss some of the key trends shaping the UK retirement market and don’t forget to subscribe.

¹Source: Bank of England, 2024.

Risk Warnings

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time and depend on personal individual circumstances. There is no guarantee that any forecasts made will come to pass.

Fixed income risk Two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to repay the principal and make interest payments.

Important Information

This is marketing material.

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

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MKTGH0824E/S-3809688

TinaShe

Hello and welcome to pension ship blackrock's podcast series for professional investors in the UK I'm your host TinaShe and in this series will be sharing expert insight and opinions on the key trends shaping the UK retirement market we encourage you to subscribe to the series so they land straight on your podcast platform without you lifting a finger so onto today our focus is on a whole portfolio solutions as private investments grow and investment portfolios become more diverse having a consolidated view of risk and exposures because public and private assets is a growing challenge facing many investors we see a need for change in terms of how DC schemes think about their investment solutions to safeguard members retirement incomes and therefore super grateful to be joined by Tim Hodgson head of the UK DC platforms and retirement solutions business.

Hey Tim

Tim

Hey TinaShe

TinaShe

Right let’s jump straight in can you provide insight into the evolution of pension scheme portfolios specifically when it comes to increasing private market allocations?

Tim

Thanks TinaShe. It's been a really interesting time over the last five years to see how DC portfolios have changed and I think there's a couple of couple of things that are going on one is we've obviously seen huge growth in the asset base so are expecting to see huge growth going forward. I think that has led to and increase sophistication of portfolio design and I think that is particularly because we're considering more objectives you know we've got clients at different state different life stages of their life and so I think we're seeing at allocations become more sophisticated through the members life with more thought giving to the right allocations as people approach retirement and then move into retirement. We've also got more people at retirement age or approaching retirement age without a DB pension now so there is a lot more riding on the sophistication of these portfolios and what they're trying to achieve. I would also add I think we've seen an increase in the sophistication of the portfolios along the way so we're seeing much more precision in asset allocation all stages of that glide path where there are more tools being used and private markets is one of those and I think it's the next big thing.

The other thing I'd say is that we're seeing genuine kind of volatility in the market and we have seen that pretty dramatically over the last four years or so in many ways at the end of the great moderation as we talk about it a BlackRock, has seen a returned to this volatility and I think we've seen a need for trustees to really think about how they're diversifying risk each each part of that journey. The relationship between stocks and bonds has potentially changed and we may therefore need to be a bit more dynamic going forward. So I think you're seeing more dynamic more diversified defaults with better toolkits including private markets looking for a differentiated sources of return.

But I think we're also as I said a second ago we're seeing this demand managing defaults is more about more than about just risk in return at any one point it's about how the people manage that journey through their life and then into retirement.

So I think definitely more portfolio sophistication definitely improving asset allocation and now I think as a result whole portfolio solutions becomes a much bigger topic.

TinaShe

Thanks Tim. So it's clear then that more and more investors are transitioning to a whole portfolio approach to manage risk exposure and help bring new investment outcomes can you talk about the benefits and how you're working with clients to implement a whole portfolio approach to investment management?

Tim

So I think you know there's no question the UK pension system has been going through a period of transition but ultimately the goal of the pension system is the same the goal is to deliver better more sustainable, more secure income streams in retirement. That's what everybody in the markets here for so we've definitely seen investments move up the agenda, so whether that's for trustees or for consultants or indeed for asset managers but but ultimately for members I think thinking therefore about the design of defaults throughout that whole journey is critical and I think it's where we see a massive focus probably over the next 10 years or so.

Interesting I think outside the DC market so the sipp market we're also starting to see this it's it's going to be the case that for a lot of people their DC pension is their only source of income but for other people it will be DC or be a workplace it'll be or sipp it might be a ISAr so having good quality product and whole portfolio solutions that in those spaces as well I think is also really important.

When you think about the regulation that we've seen over the last few years but then there's a real focus on delivering better outcomes whether that's the value for money regulation by the DWP (Department for work and Pensions) or indeed the kind of current focus on retirement income and what's a good retirement income product and I think we're only at the beginning of that journey if I'm honest. But I think also we're seeing that across as I said a second ago the the DC and the sipp market and generating better secure income.

So how do we do it I suppose there's a number of answers but you know we've got over 25 years of experience of designing workplace plan design, DC plan design, whether that's a product like life path which takes you two and three retirement or indeed building great building blocks to allow other people to build great portfolios. Private markets I mentioned it earlier that is a really new and exciting area for DC investment it's not been a huge part of the DC portfolio before so getting the right product understanding it understanding how it fits in the portfolio is a really important part of the next few years

TinaShe

So pivoting slightly to climate change climate change introduces a different type of investment risk. So Tim based on our interactions how do long term investors like pension funds approach this topic?

Tim

I mean I would say this has been one of the key focus areas over the last five years if you go back to 2019 and kind of regulatory obligation to consider sustainability and climate change in your portfolio we've definitely seen schemes focus on it I think how schemes have focused on it has changed over that five years I think initially there was a kind of move towards replacing market cap index for example with some form of greener alternative but ultimately running a similar portfolio. I think we're now at a point where a lot of schemes and a lot of master trusts are building in top level portfolio objectives for climate change. I think the fascinating thing about that is how are they doing it and how are they measuring how they're doing and so that kind of need to justify and explain how you're doing and how you're going to deliver on the commitments you've already made is critical.

TinaShe

So before we wrap up any final comments on what we expect to find on the horizon?

Tim

I think some things don't change but as we've mentioned there's more sophistication coming and there is more sophistication in the process and there was a few years ago so I think ultimately it's about understanding what you're trying to do as a pension scheme understanding how you're expecting to do it and then now really importantly how are you doing against that objective you know how are we measuring that going forward so I think ultimately over the next few years we're heading towards better solutions more and better building blocks, better asset allocation, throughout the life of the member and indeed and really importantly better income in retirement.

TinaShe

Great thank you thanks Tim it's been great speaking to today and thank you listeners for joining us please join us again on another episode of pension ship goodbye.

Risk Warnings

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed.

Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time and depend on personal individual circumstances.

ESG Investment Statements This information should not be relied upon as research, investment advice, or a recommendation regarding any products, strategies, or any security in particular. This is for illustrative and informational purposes and is subject to change. It has not been approved by any regulatory authority or securities regulator. The environmental, social, and governance ('ESG') considerations discussed herein may affect an investment team’s decision to invest in certain companies or industries from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

Important Information

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons.

This document is marketing material.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2024 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, and iSHARES are trademarks of BlackRock, Inc. or its affiliates All other trademarks are those of their respective owners.

00:00:01:03 - 00:00:07:21

TinaShe
Hello, and welcome to PensionShip BlackRock's podcast series for professional investors in the UK.

00:00:07:23 - 00:00:30:02

I'm your host Tinashe, and in this series will be sharing expert insight and opinions on the key trends shaping the UK retirement market. We encourage you to subscribe to the series so they land straight into your podcast platform without lifting a finger. So only today our focus is on institutional use cases of exchange traded funds or ETFs. Is there otherwise?

00:00:30:02 - 00:01:04:06

Nine ETFs have emerged as one of the most transformative financial innovations of this generation. The advent of ETFs over 30 years ago equipped investors of all types with an efficient way to access a wide range of market exposures with liquid transparent execution, institutions have found increasingly innovative ways to integrate ETFs into their investment strategies, and a third of embracing ETFs, as they have repeatedly demonstrated that utility in challenging environments, given their deep liquidity relative to their underlying markets.

00:01:04:08 - 00:01:28:03

The purpose of this podcast is to discuss two of the most common use cases of ETFs optimizing cash flow management and efficient portfolio management. Now, to bring this to life, we will be hearing directly from two institutional ETF users who will discuss these use cases and the utility of these applications for their investment portfolios. So firstly, I'd love to introduce Jia.

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Jia is a multi-asset portfolio manager in the Energy Treasury and Investment Office. The Energy Treasury Investment Office is a team of in-house investment strategists and fund a fund managers for Prudential UK with expertise in investment strategy, design, portfolio management and Manager Oversight. This is the team behind many of the Prudential funds, including the UK's largest with profit funds.

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TinaShe
Hi Jia

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Jia
Hi.

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Nathan
Secondly, introducing Nathan Rollinson. Hi, Nathan.

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team great to be here. Thanks for having me.

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TinaShe
Thanks for joining us. Nathan is an investment manager at Avon Pension Scheme. Avon is a local government pension scheme with assets of around £6 billion,

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Unknown
150,000 members and employers paying into the scheme ranging from unitary authorities like Bristol City Council to smaller parish councils and educational bodies as an open defined benefit scheme.

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Unknown
Their investment strategy is by definition long term and this allows them to invest across a broad range of assets and funds. Sites kick things off. My first question when you think about integration of ETFs within your portfolios, what are your key usage considerations? So I'll start with Jia

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As you know, asset allocation is crucial to portfolio performance together with how you construct your portfolio and the instruments used in your portfolio?

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Jia
As a portfolio manager, I navigate two key considerations when it comes to utilizing ETFs. Firstly, there is no one size fits all answer each investor's circumstances, objectives, market timing and the product availability play an important role in determining how and when to incorporate ETFs in scenarios blending often seeking managers with indexing ETFs proves advantages, while in others relying solely on alpha seeking managers has better outcomes.

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Unknown
Additionally, governance costs associated with identifying and monitoring alpha seeking managers also need to be considered. Some investors with limited budgets may keep their portfolios in index portfolios

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TinaShe
Thanks you and over to you, Nathan. What are your key considerations?

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Nathan
Yeah sure thanks ten So process. Yes relatively simple so we use ETFs for capital management purposes so the product needs to fulfil I would say four kiosks, the first one being liquidity and having a liquidity profile equivalent to cash. So there are situations where it will need access to capture very short notice.

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So having to rely on something that takes days, weeks, sometimes even longer to liquidate is going to be problematic for us. Secondly, it needs to track our strategic benchmark closely with the huge selection of ETFs out there. Now. Yeah, that would be achievable even for those with the most diverse investment strategies. And then it needs to be low cost, right?

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This is really critical for us. Seems low point of setting cash back with a high cost product. And again, the level of customization in ETF strategies meant that we could target a very specific fee load, which was great. And then I'd say last but not least, is the ability to to kind of set parameters upfront and then have a manage and run the mandate on our behalf, which at a BlackRock is carried out by the index asset allocation team.

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So I'd say ensure liquidity is critical efficiency of implementation and low cost are the kind of key drivers for using ETFs within the pension fund context.

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TinaShe
thanks, Nathan. So now we've discussed the considerations. I'm going to move on to the use cases. Having cash in a portfolio is a crucial component of managing inflows and outflows, but with that often comes cash strike and a movement away from deliberate asset allocations.

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ETF Liquidity Solutions are essentially portfolios of ETFs designed to enable investors to set aside a portion of their portfolio to be liquidated quickly if the need arises. Aiming to solve the issue of excess cash without compromising on other investment objectives, returns or liquidity.

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So back to you, Nathan. Avon have been invested in a liquidity strategy with BlackRock since 2019. What was the rationale behind this strategy for your scheme and how did you go about working with BlackRock on the construction

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Nathan
Sure. So let me just just for a bit of context. First, maybe our private markets allocation has been evolving over the past few years, but 2019 really marked a step up in our allocation to real assets, particularly infrastructure.

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And today our allocation to private markets equates to something like a third of total fund assets, a really sizable chunk of total assets under management. And then you combine this with a really capital intensive risk management strategy means that we need ready access to liquid assets. And this is really what prompted us to start talking to BlackRock about cash management solutions.

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For us, divesting from equity or fixed income portfolios to fund cash flows wasn't always practical, particularly under pooling arrangements. And critically, we needed something that was going to mitigate the drag on performance from from just holding cash is, as you've highlighted in I mean, for me nothing highlights the use case for ETFs better than the the 22 Gilts crisis.

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We run a leveraged equal portfolio, like many others, really felt the strain when yields spiked. So having access to a pool of liquid assets kind of helped us weather that storm and meant we were largely able to carry on as usual, where perhaps others who were less fortunate.

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TinaShe
Yeah, absolutely. And how is that portfolio evolved over time?

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Nathan
Yeah, I mean, we've been through several iterations with that team to ensure that the combination of ETFs that we're using are keeping pace with our strategic asset allocation.

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So for instance, we've we've recently added a Paris aligned equity ETF and we use a combination of fixed income ETFs as a proxy for some of our absolute return investments. I'd maybe just say that with cash rates where they are, we may choose to hold a little less in ETFs and a bit more cash. But I think the point here is having a product that's nimble enough that you can adjust dynamically for the market conditions is is key.

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TinaShe
Thanks, Nathan. Now while liquidity, please, a one way of utilizing ETFs, it's clear that more and more investors are utilizing ETFs for efficient portfolio management, such as a portfolio manager running several multi-asset strategies.

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How have you integrated ETFs into your portfolio management processes?

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Jia
Thank you Tin for this great question. We can discuss some examples of how institutional investors potentially can use ETFs, given that was application of higher years on offer and improved credit quality and fiscal strength of many emerging market issuers.

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Emerging market debt, for example, allocation now exists in many multi asset portfolios. However, investing in emerging market debt faces many challenges. For example, idiosyncratic risk and unstable credit risk exposures. The beauty of using active managers are they can be more selective, avoiding companies, sectors and countries that face certain risks and challenges and take advantage of market inefficiencies. Active managers can also invest in off benchmark securities and use issuers that are often absent from the ETF investment universe.

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However, not all endowments are conducted for alpha generation and active managers might have capacity issue to absorb large allocations in this space. The benefits of using ETFs are that they are traded or exchange. Provide transparent pricing and they can be implemented quickly. If timing is critical, we can use ETFs to access the market first while searching for active managers.

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Jia
India is another example. India has been one of the fastest growing major economies over the past two decades. The income market has rallied since the COVID pandemic on the back of its cross-sector sector reforms maturing capital markets, favorable demographics, supply chain ships and the digitalization are all. India's extended election has triggered significant market volatility. The stronger of a longer growth story in India is still intact.

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Still earnings growth also buffers market volatility. However, investors may face several complications assessing local Indian exposures directly. For example, investors must require a foreign portfolio investors license. So for investors who do not have a license but very keen to get into India, equity market ETFs can be an option. Using ETFs, Investor can directly access multiple Indian stocks in a timely and efficient way, and ETFs tend to be cost efficient and provide transparency.

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TinaShe
Thanks each year and with the advent of private markets, I know that yourself and your team have used ETFs to complement some of your private market allocations. Can you talk to our listeners about how you've done that?

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Jia
Sure.

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One example we can discuss is how ETF can complement your estate allocations given its meaningful long term return, potential inflation protection and the diversification benefits. Real estate allocation has been an important building block for constructing multi asset portfolios. There are different ways to get exposure to real estate assets, either through private or direct real estate. All we can invest in real estate investment trusts, ETFs, real estate investment trusts have real estate cash flows by trade exchange and offer greater flexibility, lend direct to real estate, and they also pay out large part of their income.

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In addition, direct real estate transactions can take considerable time to complete, and real estate investment trusts can complement real estate allocation. In the short term, however, investing in individuals can be time consuming and challenging in determining the best investment options rates. ETFs can be useful. In this case, it's ETF investing a diversified basket of routes, making it easier for investors to gain exposure to the real estate market.

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Of course, ETFs offer several benefits, but they also count with some risks, including market sector and concentration risk. Large investments may need to consider transacting over multiday periods to avoid market price impact.

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TinaShe
Thanks to you. Now pivoting slightly to our last section of the podcast, I want to talk a bit about sustainability. So at BlackRock we are seeing an increase interest in sustainable investment solutions with our clients and across the institutional landscape.

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We recently conducted a survey of around 200 global institutional investors and 56% expect to increase their allocation to transition strategies over the next 1 to 3 years.¹ So sustainable investing and the transition to a low carbon economy have driven a greater adoption of customized solutions as investors seek to implement their own specific sustainable objectives, as well as a risk appetite index provide a preference and implementation preferences.

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TinaShe
So my final question of the day to you both. With this increasing focus on sustainable investing and investors looking for solutions to support the transition to a low carbon economy, how ETF and index strategies are helping you to integrate these considerations into your portfolios? I'll start off with you, Nathan.

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Nathan
Yeah, thanks. And look, this is a really critical area for us.

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We've set a 2045 net zero target, which is highly ambitious and all stakeholders want to see that we're integrating ESG and particularly climate in every aspect of our portfolio. So short term, more tactical holdings included.

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I've already mentioned the addition of the parts aligned ETF, but another kind of key advantage for us is the ability to monitor the strategy in terms of ESG scoring and carbon intensity and then to go on and use that information.

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Nathan
And our Tcfd disclosures,

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TinaShe
Thanks, Nathan. And Jia How ETF and Index Strategies helping you to integrate these considerations.

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Jia
ESG considerations are reflected in M&G’s purpose. We've set ourselves the broader goal of embedding sustainability in our investment processes to help people live their lives they want. But while considering the impact on the world and continuing to deliver strong returns for shareholders and customers in the long term, we have a responsibility to consider ESG factors when we invest our customers money and to use our influence to encourage companies to do more to tackle sustainability issues.

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ESG, ETFs and index strategies can be useful for liquidity and management and also help to screen out controversial business areas. Yes, ETF can be a very cost effective way to incorporate responsible investments into our portfolios.

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TinaShe
Absolutely. Okay. Well, that takes us to the end of our podcast.

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Thank you so much, Nathan and Jia, it's been great chatting to you about all things institutional usage about today.

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And of course, thank you for our listeners tuning in to another episode of PensionShip and we do hope you'll join us again soon. Goodbye,

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Institutional use cases for ETFs

¹ BlackRock iResearch Services global survey of 200 institutional investors with US$8.7 trillion of assets. May-June 2023. Survey covered institutional investors’ attitudes, approaches, barriers and opportunities regarding transition investing.

Seun Fayoyin
Welcome back to PensionShip podcast series from BlackRock for professional investors in the UK. I'm your host, Seun Fayoyin. And in this series, we'll be sharing some expert insights and opinions on some of the key trends shaping the UK retirement market.

As always, we do encourage you to subscribe to the series so that you can get all the latest episodes straight to your podcast platform without lifting a finger. In today's episode, we'll be focusing on a recently published white paper which discusses the role that an outsourced chief investment officer, or OCIO, as they often called, can play in navigating different market environments. And I guess to add credence to this, the concept of outsourcing is actually one where we've been hearing a whole lot more from clients about as they look to capture opportunities presented by the markets.

And so joining me to discuss this topic are three experts from BlackRock whom I'm delighted to be speaking to you and co-authors of the white paper. I'm pleased to welcome Lara Edmonstone-West, senior member of the UK OCIO business team at BlackRock. Devan Nathwani, Portfolio Strategist within the BlackRock Investment Institute (BII), and Paul Sheffield, CIO for UK pensions. Lara, Devan and Paul, welcome to the podcast. It is great to have you on.

Right. So as you'd expect, I've actually read the white paper, which is really interesting and there's a lot to unpack there in terms of the role of an OCIO. However I'd like to start us off with the macro picture. So Devan, the foundation of BlackRock’s outlook for the past couple of years has been on how the great moderation is over and how we're now in a new market regime for investments. Can you explain what the great moderation is and summarise what this new market landscape is from a BlackRock perspective?

Devan Nathwani
Absolutely. Thank you Seun. As you quite rightly said, you know, we believe that we are in a new macro regime that is fundamentally different to the period known as the great moderation. And that was a relatively benign period from a macro volatility perspective.

In fact, we think that this new regime, this new market environment is one shaped by supply as opposed to demand. And by that I mean a supply side constraints. Now if you look at kind of the the story we've seen in inflation, we've had this dramatic run up in inflation, primarily driven by a series of pandemic related, supply constraints. Now, some of these supply constraints are resolving themselves of their own accord. So we're seeing inflation coming down, but others are proving to be a bit more structural in nature. So we think this new regime will likely mean more inflationary pressure for the foreseeable future and a more acute trade off between growth and inflation, particularly as central banks try to lean against some inflationary pressure, over that longer term horizon.

In terms of what this means for our outlook, there's three key themes that highlight here. The first is managing macro risk, so we think that this more volatile macroeconomic environment will mean more volatile markets. And so, investors need to pay a bit more attention to the macro risk they're exposed to.

The second is really steering portfolio outcomes. So clearly what I described is a difficult environment for clients. So you know, ultimately they'll need more expertise now more than ever. So I think this calls for a more hands on, dynamic approach to investing.

And then the final theme is really, harnessing mega forces. Now, these are essentially structural drivers of return. And there are five in particular that we track. The first, is the low carbon transition. So this is the idea that economies need to reorganise themselves to be less carbon intensive, which will create investment opportunities along the way. The second is demographic divergence, which is the idea that certain major economies have aging population, whereas others have, younger and populations and those with aging populations will see that as a headwind to their growth story. The third is geopolitical fragmentation. So, if you look at the news headlines recently, clearly we're in a more fragmented world geopolitically. We've got the war in Ukraine and greater strategic competition between the US and China. The fourth is digital disruption and the emergence of AI. So this is the idea that, you know, we think on the verge of a revolution that's akin to the industrial and information revolution. We think that, you know, this will have all sorts of investment consequences, particularly if we think, as we see, companies adopting AI technology and that result in winners and losers across industry. The fifth and final mega force is the future of finance. And this is the idea that, the disintermediation of banks is speeding up, in our view, in the face of higher rates and the emergence of digital currencies and tokenisation.

So yes, a lot going on in this new macro environment.

Seun Fayoyin
Yeah, absolutely. I was going to say that it's quite a lot for investors to kind of consider, in this new market regime. But I quite like the way you've talked about things from mega forces perspective, because some of the key themes that you mentioned on there are quite prevalent in some of the conversations that we're having with clients. And I guess, Lara, coming over to you, but this new regime at play obviously there's a lot of uncertainty and so the demand for outsourcing continues to grow, and investors are turning to OCIO. But actually BlackRock has been in the OCIO space for quite a long time now. This is isn’t new to us. So can you talk to us about this?

Lara Edmonstone-West
Absolute. So, BlackRock started managing assets on a fiduciary basis all the way back in 2005. And this is when we take on responsibility for a Dutch pension scheme. And of course, we're super proud that they remain the client of BlackRock today. There has absolutely, you are right, been a large focus on this growing trend on OCIO in the UK.

It's not new. It's been around since the noughties. It was often termed FM back there, and actually there is a little bit of nuance between FM and OCIO, but we are going to stay firmly in this podcast on OCIO. But what's interesting and we'll touch on this, is we are also seeing growing appetite outside of the UK, the US for example, and also all the way out towards APAC. But what are the key drivers for why somebody would use and OCIO. So historically, I’ll stay slightly in my world for a minute^, the defined benefit or the DB pension scheme world, trustees have increasing regulation on their plates, they've got additional responsibilities. And it also goes all the way through to cost transparency. Do I actually understand what paying for and what I'm getting? There’s been some great milestone in the industry, and I’m just going to pull out a couple of these. June 2021 British Airways Pensions announced BlackRock as their OCIO. Significant mandate in the market and it has led to BlackRock managing those DB pension benefits for over 85,000 of their scheme members and their beneficiaries. They were quite shortly followed after by the Royal Mail Pension Plan into BlackRock. So here we manage around 9,000,000,000 of their pension scheme assets in that OCIO world. Slightly higher number of numbers here, we’re touching on pensions for120,000 people. So big numbers here but what's really interesting, so I touched on the US, I’ve touched on APAC. But also we're seeing increasingly discussions with multinationals. So we're talking here about corporations who are starting to look at their global pension liabilities and understanding how outsourcing can help them streamline what they do, and then I’m going to come back this to right at the end, but what's really exciting is the traction that we’re seeing into different client segments. So, family offices, insurers, foundations and endowments. So going all the way back to your question Seun. There actually is a huge demand for outsourcing and hopefully through this podcast we can touch upon some of those areas.

Seun Fayoyin
Fantastic. Thanks for that. Quite a few big key wins, that you've mentioned with the British Airways and Royal Mail and but I guess it's fair to say that OCIO is not just for the large clients right? There's a spectrum of clients that this can be, applicable to. And so, Paul, coming over to you and reflecting on the white paper, you talk about three key themes in there; one steering portfolios, two managing macro risk and three, harnessing mega forces, starting with the first theme. How is BlackRock steering portfolio outcomes for its OCIO clients today.

Paul Sheffield
Yeah. So I think steering portfolio outcomes is going to be critical in the environment that Devan has spoken to. I think we're in for a bit of a bumpy ride. And when we think about steering portfolio outcomes for our clients, we look at it through three key levers. So the first of which, is the strategic asset allocation. So that's on average your long term asset allocation to equities, bonds and alternative assets. The second of which is tactical asset allocation. So that's how you adjust your portfolio, to take into account information over the shorter term. And then the third of which, is through manager selections, so which managers are you going to choose to implement your strategic asset allocation.

So taking each of these in turn. So we think that having a well-diversified strategic asset allocation is going to be the bedrock, of the portfolio, that you build, especially in the context of a much more choppy environment where we expect inflation to settle a little higher than perhaps what the market's expecting. So what does that mean from an asset allocation point of view? We like index linked bonds, we think equities are well placed to absorb higher levels of inflation, but we think that there's a real need for diversifying the portfolio such as alternative assets. Think hedge funds, think private markets.

In terms of active management, so from a tactical point of view, we don't think that investors are being rewarded properly for holding longer dated bonds. So, we think that they're looking more expensive. So we're underweight, long dated global government bonds. But we like equities, because we think that the environment at the minute is supportive of growth, especially in Europe rather in the US. So headline we’re underweight, global government bonds and were overweight equities.

And then finally managed selection. We think that in the type of environment that we're in, it's a fertile breeding ground for a good active manager to deliver excess returns for the portfolio. So to summarize, we think well-diversified strategic asset allocation, stay nimble, so that you can react to the market environment as it evolves.

Seun Fayoyin
Thanks for that, Paul. very insightful. And so sort of linking that asset allocation piece to the second theme, which is managing macro risk. Do you want to elaborate on that a little bit and talk about what this means in an OCIO context?

Devan Nathwani
Yeah. No, that's a good question. So I would use two examples here. The first is the story with inflation. So I mentioned earlier that inflation is falling, and towards the end of last year if you cast your mind back, you know, there was a lot of excitement in the markets around the prospect for central banks cutting rates going forwards, particularly in 2024. So much so, that at one point, markets were pricing in, to the tune of seven cuts for 2024 in the U.S that is. You know, that's quite an extreme environment if you think about it. Now, if we think about our view, at the time, our view was really that, you know, we disagreed with the market, we thought that the rates would likely stay higher for a bit longer, particularly given the sticky inflation we were seeing driven primarily by the services side of inflation. And then if we fast forward to today, and you think about sort of the recent inflation prints we've had, a lot of that seems to suggest, that the disinflation process, the falling inflation process, seems to have stalled somewhat. So all of this to say that, you know, clearly having an edge on macro insights, is quite important in this current environment. So when you're thinking about your OCIO provider, I think that's that's going to be crucial going forwards in this new regime more than ever.

So that was the first example, the second example, which is from the capital market assumptions that BII, maintain and provide to Paul's team actually. So, if we think about what we're seeing in the assumptions we produce and look real returns, what we're forecasting in the next ten years is lower real returns relative to the kind of experience of the last ten years. And, you know, that makes sense intuitively, given that inflation is higher, etc. Tut for some investors, that could be quite a complicated environment. So, particularly those that have a specific targeted return, if you're targeting 3% above inflation, and you're used to achieving that comfortably in an environment where inflation is relatively low and, you know, returns were quite high, in net inflation terms, going from that environment to an environment where, you know, structurally lower real returns is quite a difficult trade off to, to come to terms with.

So clear you need to have regular insights on what the best investment ideas are over that structural, strategic horizon. And that's why, my team in particular, produces quarterly capital market assumptions. We give that to Paul’s team. So that he and his team can really, reassess and revisit client portfolios on a more frequent basis, than perhaps those who are only doing it on once a year, for example.

Seun Fayoyin
Quite a lot of assumptions, that must keep you guys very busy indeed. Paul any thoughts to add?

Paul Sheffield
Yeah. So I think I'm going to come at this from more of a governance angle. And we think that having a strong governance process in place will provide the scheme or schemes with the ability to act quickly, if they need to, to evolving information. For example, new capital market assumptions or inflation adjusting quicker, and perhaps expecting more rates and so on and so forth.

And then when you think about that, I'm going to frame in to two broad buckets. So we have BAU, business as usual, and then what if we're wrong. So you can think of BAU or business as usual, as our base case. So in terms of that what we need to be able to do is adjust the portfolio for tactical opportunities, and to adapt strategic positioning in the event that new information does become available.

So this is where things change. And we know something today that we perhaps didn't know when we were setting the original asset allocation. So for example, imagine a scenario where inflation falls much more quickly than expected. Interest rates revert to pre-pandemic levels and our expected returns increase dramatically. We'd want to be in a position to adjust the portfolio in a way that capitalises on that type of environment.

And then in terms of the what if? So that's what if we're wrong, the oh dear moment. So we monitor portfolios, every day and we're continually asking ourselves, you know what if we're wrong, what if our base case isn't going to play through. What if this is a big shock and we do that through stress testing our portfolios to understand how they might react to a material market event. So such as a recession or an escalation of conflict in the Middle East. And what that allows us to do is to have a plan in place so we can act quickly, if we need to. So in summary, to help us, manage macro risk, in our view, we think we need to be nimble, we need to have a plan in place in the event that things don't turn out as we expect.

Seun Fayoyin
So we've spoken about steering portfolios and managing macro risk. The third investment theme that was discussed in the paper looks at the five mega forces which were mentioned earlier. So can you expand on these mega forces and touch on the opportunity set that they open up for clients? And Lara, I'm going to come over to you first. And then Paul, I'm happy for you to jump in too.

Lara Edmonstone-West
Perfect, thanks Seun. So let's start with a reminder about what these five mega forces were. So they were digital disruption and artificial intelligence, a fragmented world, the low carbon transition, demographic divergence and the future of finance. But what's important about them is what they mean. It's way for investors, so Paul as a CIO for the portfolio, can think about how he’s going to align his portfolios with the trends that are going to shape the future. When we look at these, we look at long term trends and also short term trends or themes because they're both really important. And actually to bring it to life, we're talking about which companies might lead the way as economies grow and markets evolve.

But actually, I guess what’s of most interest to me from a personal point of view is what my clients, prospects and those people I talk to see. So where is there appetite and interest. So it's definitely around the low carbon transition. It dominates headlines, we see it everywhere but also digital disruption and artificial intelligence. The reason for this I think is really obvious. It's fast moving, it's super exciting. And trustees often see it in their day-to-day working lives in terms of what it means for perhaps the companies that they work for. So I guess, Paul, do you want to talk about both of these in terms of what it means for the portfolio?

Paul Sheffield
Yeah, sure. There's a there's quite a lot to unpack there actually. I totally agree, the low carbon transition, it's hard not to have a conversation that involves that as a subject with our clients. But the way we incorporate that in our portfolios is twofold. So first of which is through the strategic asset allocation. So the capital market assumptions, which, Devan, comes up with, they take into account, how asset classes will behave in the future as we transition to that low carbon economy. So what does that mean for our portfolio? It's going to influence the asset allocation of our portfolios, because we want to allocate to those regions and assets that we think will do well out of that transition, to the low carbon world.

In addition to that, when we're implementing that, that strategic asset allocation, we want to select managers that we think are well positioned, to benefit from that theme as well. So in the private market space, for example, we allocate to a sustainable private markets vehicle. In terms of digital disruption and artificial intelligence, as Lara said, this is in my view, anyway, really cool, because what we've been able to do is introduce data innovation tools such as text scraping, which monitor and assess central bank policy statements, which has helped inform our success for short duration view. It also enables us to take into account other fast moving data points, such as job postings, so we can take all of this information into account, which feeds through into our tactical asset allocation views that we put in place, in our OCIO portfolios.

Seun Fayoyin
Thank you both. Finally, to wrap this up for this session, Lara, I'm going to come to you and ask you to really dig into your inner psychic abilities here and kind of look into your crystal ball. And as we look forward and think about the future, can you talk to what you think the future holds for the OCIO client segment?

Lara Edmonstone-West
Absolutely. Some of it, I think we're more certain about this than others. I think some of it is going to come over time and we'll see which areas move the quickest. I'm going to start again in my core world, which is DB pension schemes. We continue to see opportunities here in OCIO, partnering schemes at every stage of their life cycle. And I think what's really interesting at the moment is the conversation out there about surplus, and kind of what that means. So OCIO for DB schemes is absolutely there. No podcast is complete without talking about autumn 2020 and the gilts crisis. It has changed where schemes are in their end game and OCIO can continue to help navigate this journey. And you know what happens again, help them navigate it a little bit smoother.

I spoke at the beginning about regulatory squeeze, it haven't stopped. It's there for the right reasons, but that does mean that trustees can be quite overwhelmed. What they need to be able to do, is focus on the bigger picture and I know an OCIO enables them to do that.

But it isn't just pension schemes that are leveraging our broader OCIO capabilities. As I mentioned earlier, we’re seeing interest everywhere. So insurers, family offices, foundations and endowments. So we're talking across the institutional spectrum. And I'll touch on each of these briefly, so insurers. What's the nuance here of insurers, what they're doing is they're reevaluating what they want to see from an operating model perspective in an OCIO arrangement. So I’ll look back to April 2023, when LV= selected BlackRock as their primary asset manager. Why did they do that? Because they wanted their members, customers and all of their financial advisors to have that access to that deep investment expertise. And that's what BlackRock's been able to do for them. And ultimately, why does that matter? Because it means they can give those long term investment solutions across their member and customer base. And that's been a huge enhancement to the LV= offering.

In terms of the nuance of a family office. It's really different. So what drives demand here? It’s about potential investment returns that they would get. It's about having institutional risk management, perhaps they haven't really got it at the moment. Cost considerations and succession planning. So actually my world, in the DB world, succession planning has been a big theme. It's no different in family offices, perhaps they've got a CIO on the family organisation side, and they really need to think about what happens there.

Another driver and something that’s super interesting is generational wealth transfer. And what does that mean? And how does that change how you invest for the family office? And an OCIO can come in here and help them navigate that change.

And then I'll finish up with foundations and endowments. So Devan and Paul have spoken about the market volatility and some of the the challenges that that can bring, and that need to be nimble. But in foundations and endowments there's also increased scrutiny. So here I'm talking about the charity commissioners. And actually what it means is being nimble is really key. And outsourcing can assist trustees with some of the new guidance that they now have to meet, so that regulatory burden that I spoke about earlier. Probably not too dissimilar to many people listening, they probably only meet on a quarterly basis. So what does that mean? It means that decision making can be delayed. And given current market environment, that can actually be unfavourable for portfolios. Maybe you fail to protect on the downside, or maybe you fail to capture on the upside. So the OCIO is no different, the theme is consistent. It's that daily management, giving you that investment and risk quality approach to the portfolio.

Seun Fayoyin
Excellent. thanks a lot for that Lara. And that's all we have time for today. I think we've covered a lot. We've talked about the five mega forces shaping the new investment regime, the increasing role of outsourcing, and the role that OCIO you can play in navigating in this market environment. And the fact that there are several client segments where OCIO plays a pivotal role in.

Thank you again, Lara, Devan and Paul for your time today. And to our listeners, join us again soon, where we will be discussing some of the key trends shaping the UK retirement market.

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PensionShip: Episode 1

Illiquids: Nothing Will Pay Off More Than Educating Yourself

BlackRock Speakers: Seun Fayoyin (moderator) and Simona Paravani Mellinghoff

External Speaker: Brendan Walshe from The Pensions Regulator

Seun: Welcome to the brand new season of our podcast series. This year we renamed our podcast to Pension Chip, PensionShip is a podcast series form BlackRock for professional investors, where we share expert insights and opinions on some of the key trends that are shaping the UK retirement market. I’m Sean Ryan and I’m delighted to be your host for this season.

Over the course of the year, we’ll be joined by some fantastic guest speakers who will be on hand to share their insights and thoughts on various topics, including fixed income or CIO, hopefully solutions, ETFs and a host of other great topics. So please do subscribe to the series so that you can receive every edition of the podcast straight to your platform.

Onto Today, we’ll be kicking off with a focus on private markets. There is no escaping the fact that private markets is increasingly topical and has become really a key area of consideration for investors looking to make portfolio allocation decisions. Joining me to discuss this are Simona Paravani Mellinghoff, who is the global CIO of Solutions for the BlackRock Multi Asset Strategies and Solutions Team.

Seun: Simona, hello and welcome to you. It is great to have you on the podcast today. Do you mind telling us a little bit about yourself?

Simona: Thank you so much for the invite. My colleagues and I have the privilege of partnering with pension funds, sovereign wealth fund and wealth managers to provide customized multi asset solution as well as fiduciary, sometimes known also as OCI or services.

Simona: In addition to my role at BlackRock. I’m an academic at Cambridge University where I teach a course in artificial intelligence applied to finance a topic that is very much top of mind for investors in private and public markets. That is fantastic.

Seun: Sounds like you have got a very busy schedule. Also joining us is Brendan Walshe. Brendan is a principal and investment consultant at The Pensions Regulator.

Brendan, welcome to you and thanks for joining the podcast. Are you ready to share some fantastic insights?

Brendan: Thank you, Sean. Hopefully I will do. I’m Brendan Walsh. I’m an investment actuary at the Regulator and I’ve been there for nine years now. My role involves everything to do with investment trusts. DB DC Master Trusts, super funds, anything with an investment tag to it.

Brendan: I’ve also worked a lot in my past life with infrastructure investment and other private markets and I specialize quite a lot in in climate, ESG and water sustainability issues.

Seun: Thanks, Brendan. Great to have you on. So let’s jump straight in. We know that the investment markets have been dogged by significant volatility and uncertainty as a result of several factors, including the current interest rate market environment, inflation, geopolitics, to name a few.

Seun: However, we can’t escape the buzz surrounding private markets. Can we actually start off by discussing the current market environment and why private markets could play a pivotal role in delivering better outcomes to investors? Simona, I’m going to come to you first.

Simona: Well, big picture, the quote that comes to my mind is inspired by George Orwell. We can say that the future is by definition uncertain, but some parts of the future are a lot more uncertain than others.

Simona: And right now it feels very much that way as we have uncertainty on multiple fronts, starting with the macro picture. Will inflation moderate? And if so, to what extent, given some of the pressures from mega forces such as an aging population, we have of course uncertainty on the geopolitical front and we have uncertainty linked to structural changes related to mega faucets like artificial intelligence.

Simona: Against this backdrop of great uncertainty, the role of private markets that we define is a rather integral genius group of assets ranging from VC to real estate is even more relevant and it is even more relevant for three key reasons potential for diversification, potential for return announcement and potential for inflation mitigation.

Seun: That is great, Simona, thanks for setting the context in terms of the current macro backdrop and for also emphasizing the key fact that the private market landscape is not a homogeneous one.

In fact, it is one that consists of several different underlying asset classes to consider. And I love the three piece that you mentioned. Do you want to elaborate on that a little bit?

Simona: Let me start with potential for diversification. Investing in private markets is a way of accessing less correlated or in some cases even uncorrelated sources of return, where some of the drivers of return are really down to fairly idiosyncratic factors.

Simona: A good example of this is music royalties. The sheer breadth of the underlying investment universe also speaks to the diversification potential and let the numbers do the talking. Here in the U.S. market, for example, there are about 5000 listed companies, but there are also 36,000 VC companies. VC backed companies and about 16,000 PE or growth backed companies. So diversification in numbers, moving to the potential for inflation mitigation.

First of all, why is it relevant? It matters because while we believe inflation will moderate, we still expect that on average inflation on a medium to long term horizon is likely to be closer to the 3 percent rather than the 2 percent mark. For a country like the U.S., we’d expected inflation be more elevated on average than in the past.

Asset classes like infrastructure or real estate do tend to have an explicit inflation linkage in their revenues. Stream may help mitigate the inflation impact on portfolio returns. And finally, potential for return announcement. When we look at our capital markets assumption of risk in return for a broad set of assets, all of these are available on our website and updated quarterly expected returns for assets such as direct lending or opportunistic credit, not to mention P are still expected to outperform public equity on a medium to long term horizon.

Seun: So investing in private market is important because of the potential for diversification, potential for inflation, mitigation and potential for return announcement. And Brendan, is there any other thoughts that you would like to add?

Brendan: Yeah, I mean, I’d agree with a lot of the investment characteristics which someone have mentioned. I think the other thing that’s really important to bear in mind here is some of the industry dynamics, and I know some have mentioned some in each population, but if we look in the UK, the pension landscape is changing dramatically.

Brendan: So in DB, you know, we’ve had very recently significant improvement in funding levels for a large number of schemes and we’ve had an increase in the level of transfers to insurers. 50 billion was transferred to the insurance market last year and they expect a similar level this year. But you’re also then seeing some other new initiatives not following the Autumn Statement last year, the potential for schemes to run on the scheme longer and how much of a surplus from that scheme and super funds, which is the first super Fund transaction, was announced in in November last year and we’ve also seen very today the launch of the details of the public consolidator.

Brendan: So there’s a lot of change in DB and that affects the types of private market investments that different schemes might want to consider for investing. We’re also seeing in DC where the market is still to a degree in its infancy, but only a 10th of the size of the DB market. But it is rapidly changing and we’re seeing schemes of building scale, We’re seeing developments in investing to and through retirement, which all feeds into changing the needs you might have for private market investments and the investment horizon change and the characteristics you’re looking for.

So we think we’re moving to another phase of development. We’re going to have fewer, bigger and better run schemes. And alongside that we’re also having more focus on better trustees more generally.

Seun: Brendan You touched on the Autumn Statement just now leaning a little bit more into this. There’s clear political and regulatory momentum in the UK to encourage pension schemes to consider investing in illiquid assets and really commit more money to the private market space.

Can you touch on some of the factors that are driving this growth momentum and what are the key benefits and opportunities for pension schemes and their members as a result?

Brendan: Yes, certainly. I mean, I think firstly as a regulator, it’s very important to say that we don’t direct investment. We are an arm’s length body. We operate in line with the regulations, but we don’t tell trustees where to invest.

We expect them to take appropriate advice and to make decisions that are in the best interests of their members. However, you know, it’s no secret that in industry there has been a lot of mood music. Our government has been very much around investing UK policy, investing in product finance, investing in high growth equity and some of that music has been clearly driven by the fact that overseas pension funds, Canada and Australia in particular, have been investing quite heavily in UK ports and so that’s to say, well, why aren’t UK pension schemes investing?

Brendan: Who keep you on, see, and if that there are some structural reasons for some of that given the regulatory environment, given the, you know, the button, the boundary conditions that schemes in the UK have to operate and they’re managing the risks against the appropriate regulatory structure. But, you know, I think private markets, as some have mentioned, isn’t one single thing.

It is a very broad universe of opportunities and risks. And within US asset classes. So basic class and individual investments, the way you access them also influences the risk profile. So I think, you know, you sort of think of it in terms of there is an opportunity probably on the back of the government momentum, but it’s no harm for trustees to be asking their advisors and service providers, can we do these investments in the UK?

Brendan: Are there opportunities in the UK and forcing those decisions to be had? But I think it’s just it’s more around. There is interest in the space, there’s a spotlight being shown on the space and I think the momentum seems to be that, you know, trustees will be asked to, to explain in future disclose and explain requirements if they’re not investing in some of these asset classes.

So I think it’s just it’s just the current momentum in markets. But at the end of the day, trustees, a fiduciary is they need to take advice and make decisions in the best interests of their members.

Seun: Very insightful, symbolize there anything else that you’d like to add to this?

Simona: I think the momentum largely reflect what I described earlier potential for diversification, potential for inflation, mitigation and potential for return announcement.

Simona: There is also very interesting international evidence on the beneficial impact of investing in private markets for pension fund. So as an example, BlackRock did publish a study entitled The Peer Risk Study Australian Superannuation Market, and based on data available as of September 2023, we showed that for large size Australian funds, the experience of those that had invested 20 to 25 percent of their assets in private markets was a positive one in the sense that they tended to outperform their peers.¹

Seun: Thank you. Similar really interesting results from the survey that you’ve actually mentioned. It looks to us that there’s a lot that we can learn from some of our peers in other regions like Australia. Now Brendan, coming back to you and giving your regulatory hat on, In January, the Pensions Regulator released some guidance on private markets, which speaks to the need for schemes to take appropriate advice and governance when allocating to private markets.

Seun: Can you touch on this and do you see this leading to a bigger role for fiduciary management? Because this is actually something that we often get asked?

Brendan: You know, certainly I mean, I think first you should say that we don’t produce guidance, just say producing guidance. We produce guidance to hopefully meet a need, an industry. And over the period September two to December last year, we engaged with industries and informed or guidance by discussions with industry and or guidance is also informed by what we’ve done with the Finance Working Group, which had been in industry from 2021, 2022 and produced the first report which dealt with some of the barriers to two DC schemes investing.

In illiquid and private markets and the second report in November 2020 to produce a suite of guidelines to help overcome some of those barriers. So it what we did, it’s not a manual for investment, but hopefully what we would like it to do is ensure trustees are better informed and can have more informed discussions with their advisors and service providers and hopefully lead to better outcomes.

Brendan: Risky members in terms of fiduciary management, I mean, as someone who was before I was the regulator was an investment consultant, an industry for many years across the usual suspects. I would certainly see the potential for fiduciary management and know the service providers having a big role here. You know, one of the things we have seen and we produced a series of blogs in line with the Finance Working Group as well, was one of the challenges has been the level of innovation and DC has been very limited compared to DB.

DC has very much been a poor relation. Now that’s been the story to date, but DC is now starting to get scale and momentum and we know we’ve seen in the markets last year I think NEST hit 30 billion for the first time and in their annual report and accounts they have contributions around 6 billion a year.² So you can see why some of these schemes are going to get significant scale quite quickly.

Brendan: And it’s not implausible that for the end of this decade, necessarily bigger than in a large scheme we have in the UK, which is UCC currently. So a lot of money going into these, a lot of opportunity and I think innovation will happen in that. One of the challenge with private markets is it is a very broad universe.

Brendan: Timing investment is very important. The governance modes are quite high things. So if they go well, the governance demands are high. If they go wrong as can happen to times, the governance matters. Rocket So I think you just need to be aware that these things do need a little bit of care and maintenance, do need a little more engagement from trustees.

Brendan: And, and I think that’s plays into the fiduciary management sector because if you’re scheme governance doesn’t enable you to do that, then outsourcing it to fiduciary management manager or another service provider is an obvious route to that. And finally, just make the analogy with TB. When I was in the industry many years ago, fiduciary management was, if you like, being imported from the continent and people trying to get traction in the UK, some of the early adopters were sold on the basis of use fiduciary management to do your alternative portfolio.

Brendan: And that sort of built the case and then people expanded from that. And I think in similarly in DC and private markets, there is that opportunity that you do need providers, we’ve got the resources to scale and can build multi year portfolios across strategies and opportunities.

Seun: Perfect. Taking a slightly different tact and thinking about sustainability or looking through the sustainability lens, as it were, this is obviously very topical.

In fact, I don’t think I’ve been in any conversations with any clients over the past 24 months where sustainability was either not reference or it wasn’t a key area of the conversations. We know that ESG considerations continue to be critical for investors when it comes to reviewing their investments. So how does this impact the potential allocations to private markets? Simona, I’m happy for you to jump in here.

Simona: The unique access and control features of private markets can be a meaningful help in achieving a particular sustainability goal, starting with access. The ability to invest, for example, in infrastructure is a one way of potentially participating directly in the climate transition. Similarly, when we talk about control or the control that an investor can achieve by investing in a particular company through private equity is higher than through public equities in some cases, private equity investment may also result on a seat on the board, which then could translate into having a more direct impact on the desired sustainability outcome.

Simona: And this is not limited to the private equity world. Private credit is another good example. As an investor in private credit, the lender actually has the ability to negotiate the terms.

Seun: Any thoughts from you, Brendan?

Brendan: Yeah, I’d start with the investment opportunities and I think, you know, I mentioned earlier the IEA report from last year, which said by 2030 we need 4 trillion of US dollars invested in climate mitigation strategies.³

That’s up from around 400 billion currently. So there’s a huge increase over the next few years required. And on top of that, I have said that 80 percent of that money is going to come from private capital. So I think that gives you an idea of the amount of money which is there and the opportunities within that in a broad spectrum within private markets.⁴

Brendan: And the second point to make another piece is that there are some stakeholders who don’t really trust the same level of climate urgency, who don’t see the need for the same level of energy as some of us who work quite a lot in this space do. But I think if you look at where we are today, 1.1 degree, we’re targeting 1.5 around.

Brendan: And based on the latest cop, we’re probably heading to 2.7, 2.8. So we’re a long way off where we need to be. And at one point, one above pre industrial levels, we are already seeing climate impacts coming through across the globe, whether it’s in wildfires and droughts and flooding in additional insured losses from typhoons and other storm damage. So we’re seeing huge impacts already starting to come through and that’s a 1.1.

Brendan: It’s not going to be linear as we go forward is going to be worse than that. And so we do need to adapt and we do need to build resilience and we need to get ready for the future. You know, it’s no longer business as usual. And I think we should also help to bring this home to a across to the investor base as is, you know.

Brendan: TFT Whether you like it or not, and whether you think it’s a huge burden, what it is doing is, is ensuring more transparency and organizations are having to walk through disclosures have having to think about some of these issues. And it basically it has helped to get climate and TFT Also what is nature and biodiversity on the agenda?

Brendan: So as those sort of cascade through and you get transition plans on top of that, you know, the fact that we can’t remain in business as usual, a sense of urgency will start to creep through and I think the need for more investment will start to be patently clear, and that will be from organizations wanting to transition organization is wanting to build, to adapt to the new environment and to build resilience in the supply chains and value chain. That’s why.

Seun: Thank you. So at the start we discussed some of the opportunities and benefits of making an allocation to private markets. Can we pivot a little bit by touching on some of the challenges that investors will face, as well as some of the current barriers to wider adoption? Back to you Simona.

Simona: Indeed, there is no free lunch.

And so with the incredible opportunity also comes some challenges to are at the forefront for many pension funds, liquidity and selection on liquidity. We think it is important that liquidity risk is assessed holistically in a total portfolio context. When one looks at private and public investment rather than just focusing on the liquidity of the former. Similarly, concerns around selection stems from the very significant dispersion in managers performance within the private markets sphere.

Simona: The dispersion is in fact orders of magnitude larger than in public markets. It is therefore paramount to have the resources, talent and data to analyse in due diligence. The managers one invest in and.

Brendan: Yeah, I mean I think there’s always a challenge in private markets when you’re moving from portfolio theory. Will this asset give me a return of this risk of that?

And of course structure and correlation factor that to portfolio implementation. It is a challenge in private markets because, you know, the assets are not always available at the right price, at the right risk point in the amount you need when you need them. And that’s just one of the challenges and that’s why you need to sort of go into private markets with a view to building a portfolio and using the portfolio to do different things for you within your scheme context.

So yes, there have been I mean, in DC, there have been some operational challenges over the last few years. Liquidity is obviously an issue for SCB and DC. I think liquidity, you know, sometimes liquidity just gets used as a big badge, but in fact it very much depends on where your scheme is, where it is on this journey, whether it’s, you know, if you’re transferring to an insurer, liquid is probably more much more of a concern than if you’re an open scheme with a long investment horizon and still accruing benefits.

New members coming in. So I think liquidity is going to be sort of seen through the right lens and through the right sleeve for individual schemes, for schemes, scale of scheme is a big issue. 72 percent of DB schemes in the UK have less than 100 million.⁵ So that does sort of then limit some of the things they might do, but that just might mean they might want to outsource some of that too.

Brendan: To others. We’ve got the governance structures and that can help them implement the strategies they want, you know, challenges, access to and route to market isn’t always evident in private markets, but following recent developments following the DC industry having sort of gone through a sort of period of rapid growth, we’re not seeing more products developing. We’re seeing more innovation being brought to market.

We’ve I think we’ve seen for tests already. Well, I think the other challenge we haven’t really touched on and it’s you’ve just got to accept it’s there and it’ll always be a challenge, I expect. But, you know, it’s something we need to work on is, is valuations and how that links to pricing in DC. If you’ve got members moving in and out, having some comfort and having a robust pricing point is quite important.

Brendan: And you know, valuations have always been problematic. In private markets. You really value evanescent when you sell it, but if somebody asks, you hold it for a long period of time. So you do get into this from ground up valuations versus room for valuations of what is the right value at the point in time and then market sentiment. So it’s challenging. But just because it’s a challenge doesn’t mean you shouldn’t do it.

Seun: Yeah, very interesting indeed. Thinking about some of the points that have been made during the course of a conversation, I’ve noted that an overriding characteristic of private markets is that they’re in fact in liquid. And this has been touched on by both of you just now.

Seun: And as a result, there could be some time to ramp up the portfolios and also potentially some time to exit. This also seems to tie in with some of the barriers to wider adoption. And so. Simona coming back to you, how do you ensure that we build sufficient dynamism as possible with a multi alternative portfolio approach in order to be able to navigate through market environments, particularly in the ramp up stage?

Simona: I would say that the key to dynamism is a holistic approach, holistic approach to the opportunities, the risks and the implementation options. On the opportunities side, through our capital market assumptions, we look at returns across public and private markets using a consistent framework that enables us to compare opportunities across the entire spectrum and deploy capital accordingly. Similarly, on the risk side, it is important to view risks not just through an asset class lens, but with a risk factor lens, something we do via our Aladdin platform.

Simona: Let me illustrate the importance of this point with an example. Let’s assume that in a portfolio we have an investment in commercial real estate in Texas as well as a gas pipeline in, let’s say, Europe. The reality is that if one looks at risk just at an asset class level, one may actually miss the correlation between those two investment that comes from their more or less direct exposure to commodity prices.

Finally, one should take a holistic approach to the implementation choices. So, for example, one should leverage options like secondaries or co investment to limit the j curve. And furthermore, one can use the risk factor lens to proxy private market exposure through public markets in the ramp up phase for private markets.⁶

Seun: Thanks for that, Simona. And so, my final question goes to the both of you, and it will be on the future of the private markets landscape as we consider the evolving nature of private markets.

Seun: If you had to highlight one image, an aspect that you find particularly interesting or impactful as we look into the future, what would that be? Brendan, I’m going to ask you to jump in first.

Brendan: Yeah, well, if I may, I’m a throw to into the mix because I think the industry dynamics are key, certainly in the pensions landscape, moving towards fewer, bigger and better run pension schemes.

And I think that that changes the nature of where investors might want to invest and their ability to invest also. So I think that this got a key industry dynamic in DC is the future. But more generally I think the to my mind and probably because I do a lot of work in climate in ESG and sustainability space, is it there is going to be a huge amount of investment flowing into investment flowing into climate over the next 5 to 10, 20 years.

Brendan: And I think that is really where the opportunity set will be. There will be huge need for private capital to support that. And we are also in an environment where the market is rapidly evolving in climate, ESG, 1015, nature and biodiversity and those dynamics and that into the mix in that area and technology which will also affect all investment, I think you know, it’s never been more true than the past investment.

Brendan: Past is no guarantee to the future. I think we’re in a very live and moving environment which will change very dynamically over the next 3 to 5, ten years and not just be to the macroeconomic macroeconomy effects we’re seeing of geopolitical risks. It’ll also be the sort of more fundamentals around climate and A.I. and the digital revolution hitting home and.

Seun: Simona I noted that Brendan actually made two suggestions. I’m happy for you to jump in here. If you have two or if you have one.

Simona: I would pick the democratization of access to private markets. This is a truly global phenomenon. We are seeing more and more interest on how we can incorporate private markets in these schemes as well as in wealth solution in multiple markets UK, U.S., Australia and France.

Simona: Just to mention a few. And I believe this is truly exciting because as I hope that our podcast has shown today, there is a lot to be excited about in terms of private markets. Of course, they come with their own challenges, but the opportunity is quite significant and particularly relevant in the current market environment. So the ability to ensure that more savers and more pensioners will have access to the opportunities in private markets represent something truly exciting.

Seun: Fantastic, right. So all the points that you’ve both made certainly do resonate. It is fair to say that while there are some challenges to consider when thinking of private markets, there are also clearly some fantastic benefits to investors in making allocation to this space. Well, that is it for this episode. I believe that we’ve been able to cover quite a lot of ground in such a short period of time.

Seun: Thank you. Simona and Brendan for your fantastic insights and engage in discussion. Join us again soon. We will continue to discuss some of the key trends shaping the UK retirement market.

Risk Warnings

Value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time and depend on personal individual circumstances.

ESG Investment Statements This information should not be relied upon as research, investment advice, or a recommendation regarding any products, strategies, or any security in particular. This is for illustrative and informational purposes and is subject to change. It has not been approved by any regulatory authority or securities regulator. The environmental, social, and governance (“ESG”) considerations discussed herein may affect an investment team’s decision to invest in certain companies or industries from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

Important Information

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons.

This document is marketing material.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2024 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, and iSHARES are trademarks of BlackRock, Inc. or its affiliates All other trademarks are those of their respective owners.

¹BlackRock, Peer Risk Study: Australian Superannuation Market, September 2023.

²Professional Pensions, Nest hits 30bn pounds of assets as it continues expansion into private markets, 26 May 2023.

³IEA, Net Zero by 2050 Report, https://www.iea.org/reports/net zero by 2050, May 2021.

⁴Ibid.,

⁵Pension Protection Fund, PPF Purple Book for 2023, 31 March 2023.

⁶PitchBook, as of September 2023. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis. Underlying performance is representative of a broad set of funds.

JINGLE: PensionShip, from BlackRock.

Tim Smith: Hello and welcome to PensionShip, the podcast from BlackRock for professional investors in the UK. I'm your host, Tim Smith, and in this series, we're sharing expert insight and opinion on the key trends shaping the UK retirement market.

Tim Smith: Now we're calling this episode, The Road to a Resilient Retirement, and we'll be reviewing the retirement landscape this year and looking ahead to 2024.

Tim Smith: Joining me from BlackRock are Gavin Lewis, Head of UK Institutional Client Business. Gavin, hello again. Welcome back to the podcast. Good to be talking with you.

Gavin Lewis: Hi, Tim. Good to be back.

Tim Smith: And Peter Fisher, Head of BlackRock's Global Retirement Initiative. Peter, hello and welcome to you to the podcast for the first time.

Peter Fisher: Thank you so much. It's great to be with you.

Tim Smith: Now, in our previous podcast, we discussed the five key forces shaping the future of retirement, notably the new macro regime, affordability, demographic changes, social issues and sustainability. Gavin, broadly speaking, are there any forces that have been more dominant than others, and if so, why?

Gavin Lewis: There’ve probably been three, which have really risen to the surface. I certainly think that, like the demographic factor that we anticipated has certainly played out. I actually think that when we first thought about this, we thought it would be perhaps quite simple, like more down to individuals living longer and retirement savings having to go further.

Gavin Lewis: What we've really seen are issues that pension schemes have had to wrestle with regarding longevity. So that is not just the fact that people are living longer, but actually what role does the pension system play in that, because they have gone through quite significant change.

Gavin Lewis: And I think that change has been most keenly felt in the defined benefit pension system in the UK. So what we saw around this time last year were, it was a real increase in interest rates due to the gilt crisis and that was a result of government action in terms of trying to create more spending power in the UK economy. But the impact that that has had is that funding levels of defined benefit pension schemes has increased considerably.

Gavin Lewis: But now pension schemes are really wrestling with actually, what do they do because people are not only living longer, but suddenly they have to take account for how people actually receive their benefit.

Gavin Lewis: The other real impact has been this issue of consolidation and affordability. When we think about the pension system, we generally think about it across the three jurisdictions that we cover. So that will be defined contribution, public pension plans, local government pension schemes and corporate pension schemes.

Gavin Lewis: Actually, all three now are under consideration for greater consolidation. So that is the UK Government consulting on whether local government pension schemes that April should merge. We've seen discussions around defined benefit pension schemes and whether they should also become much larger entities. And we continue to see the organic M&A activity in the defined contribution space.

Gavin Lewis: I think the final one which we can't help but mention would be the new macroeconomic regime. So, there's been a persistence of high inflation, a persistence of higher interest rates, and that just has a huge impact on liabilities, but also how asset owners find alpha and produce returns or manage risk.

Tim Smith: Well, Peter, let's get your views then on demographic changes and also an ageing population. I understand that you've researched this topic extensively across multiple countries. Firstly, how are these developments affecting the retirement environment?

Peter Fisher: The first thing, taking Gavin’s theory of the macroeconomic trends, one of the macroeconomic trends is an ageing population and that affects the growth rate. Where we look to invest when we're investing, all of us in this industry on behalf of the beneficiaries of pension schemes, we've got to wake up and recognise the powerful impact that an ageing and declining workforce has on growth.

Peter Fisher: And so that's really important for us to keep our eye on because of those longer lives we have, we've really got to generate the returns that will carry people for this longer period of time. And what's going on in the world is what I call, a demographic divergence. There are some countries that still have rapidly rising populations. There are other countries, particularly in northern Europe that already have declining working populations and China has now, oddly, even though it's still developing, joined this group, and that becomes a retardant to growth and influences the returns we can capture when we go invest on behalf of the beneficiaries. And so that's a major challenge we all face, is to navigate this divergence in order to capture the returns we need.

Tim Smith: So what do you think then will be the retirement investment implications of this trend in demographic change or as you say demographic divergence?

Peter Fisher: Demographics has a much bigger impact on growth than we've probably recognised. For most of the 20th century we had rapidly rising populations that gave a tailwind to growth.

Peter Fisher: Now we have this divergence and so the fewer hours worked, less income gets produced in the country, there's less income to capture. That's what Japan has really gone through for the last 30 years. And now as investors, we need to navigate that. Now that's a relative value opportunity for investors who are aware of this. We want to look at countries that may be adapting better.

Peter Fisher: The Netherlands and also Japan to a certain extent have done a fantastic job of getting women in the workforce, that boosts economic growth and available investment returns. The UK still is lucky to have a rising population mostly through immigration actually when you look through that and that's part of where the tailwind comes from for the UK, but the UK's fortunate in that regard. But when we go around looking for returns, we've got to see this and see through it, both countries adapt differently and companies will adapt differently, some will be more successful than others at generating the economic income we need to pay for people's benefits.

Tim Smith: And talking then of adapting, Gavin, what have you been hearing from your clients about the challenges they're facing in relation to what Peter has just been talking about.

Gavin Lewis: I think Peter's observations are really interesting, because we haven't really factored in as much as you might think the role that demographics has played in a pension. So we typically think of people living longer in the pension’s world as a risk and hence the term, longevity risk.

Gavin Lewis: And there are some things that pension trustees and CIO's can do to mitigate longevity risk, but there's always been this view, particularly amongst corporate defined and private defined benefit pension schemes, that at some point it won't be their responsibility anymore.

Gavin Lewis: Often the role of a Chief Investment Officer of an asset owner, their role has been about, how do we get this pension scheme to full funding? How do we recover a deficit, and then how do we actually get the pension scheme off the sponsors balance sheet and typically that pressure will either come from the sponsor or the CIO will have an explicit mandate to do so.

Gavin Lewis: But I think what we've seen now is that the rapid rise in interest rates has meant that liabilities have shrunk, and actually there is a whole swathe of pension schemes now that are fully funded or in surplus, and now the option is actually what do they do?

Gavin Lewis: The reality is, is that not all pension schemes in the UK will be able to transact and remove that risk from the sponsors balance sheet. Insurance market might not have the capacity to cater for all, certainly in the near term.

Gavin Lewis: So suddenly the role of savers and trustees has changed. It's no longer just about deficit, recovery, and risk management it's actually about how do we manage the pension scheme so that it doesn't go back into deficit. But also we have to take some responsibility for meeting member’s liabilities and actually paying pensions.

Gavin Lewis: And of course, the longer that people live, the more responsibility they have, and so that is a sea change in the way that pension trustees think about their responsibilities.

Gavin Lewis: I also think it's worth just commenting on Peter's comments around asset returns and demographics, particularly in the UK immigration being a significant factor in GDP and economic performance. There's also been another demographic factor which has helped, which has been a tailwind for the UK and that is the return of and the greater inclusion of women to the workforce.

Gavin Lewis: And I do think that when you think about those, the demographic pressures that we have, particularly as we factor in some of those other risks that we mentioned and factors particularly for example, the cost of living crisis and social issues, that it's an imperative that we actually think about the role that, yes, migrants, but also that, for example, women play in the workforce as an economic tailwind.

Gavin Lewis: Which then conjures questions about, well actually is thereefficiency of providing for those individuals, particularly women. So there is, we know there is a pensions gender gap which we have to take account for. Again that's something that pension schemes never really have to think about, but it's suddenly coming to the fore. So you could see that this issue of demographics is certainly intertwined with the considerations for trustees now.

Tim Smith: Certainly a lot to think about there. Peter, have you been hearing similar feedback?

Peter Fisher: Yeah, when we look around the world, I mean, I've just spent a fair bit of time over the last year in the UK, but also other countries in northern Europe and Latin America. The longevity puzzle is going to end up on someone's balance sheet, if you'll forgive me. It may end up on the balance sheet of the pension scheme.

Peter Fisher: But if they annuitize and turn it over, they may end up on the balance sheet of the insurance company or it may end up on the balance sheet of the household, I'd like to say, and we’re responsible for our own longevity in many countries.

Peter Fisher: And so one way or another, we have to see how long we can make these assets live, pay off and that's what leads to them thinking about the asset composition when you realise how much longer people are living and how much longer we need the payouts. We think about investments in infrastructure and other long dated assets, which will provide continuous income streams. And we need to look around the world and find the ones that are most attractive and most likely to generate the higher returns.

Peter Fisher: So that's a theme across the world. And just as the UK schemes face this, schemes in other countries face it.

Tim Smith: Well, 2023 may have dampened retirement confidence due to market volatility, inflation and the cost of living crisis affecting pension contributions. But Gavin, looking ahead, what key factors do you think will be in play in 2024 and beyond?

gavin lewis: So I think many of the factors that we've highlighted, I mean when we thought about these, there's certainly long term challenges and I think they will certainly crystallise over the next few years. And in 2024 that I really think that the challenge that steers pension trustees and now sponsors have around what they actually do and how they manage, like private and corporate defined benefit pension schemes is a huge consideration.

gavin lewis: I would expect to see much larger and greater transactions in the insurance market. But I do think that there's still going to be this gap and we're going to have to see some innovation in the industry around actually managing pension schemes that are more ongoing or what we might call in the industry, low dependency or self-sufficiency basis and that requires some, some innovation.

gavin lewis: I do think though that this issue of consolidation will again crystallise, and I think that the fundamental question here is, is bigger better and how that affects different pension scheme systems, be it DB public and pension plans or DC.I think that question has yet to be answered, but I do think we'll probably see some experiments or initiatives to try and pool or consolidate assets to a much greater degree. So I think that will be the acid test.

gavin lewis: I also think that we're going to see innovation particularly in the DC market. So this year we saw LTAFs and alternative strategies launched. And I do think we'll see the first allocations of those over the next year or so. And these should allow members access the benefits that private market assets may provide.

gavin lewis: The difference here, of course, is that here we're talking about the individual as opposed to broad pension scheme assistance. And you know that the underlying theme here has been longevity and demographics. And I think as these social issues, be it around the cost of living crisis or gender, or even the ethnicity pensions gap, I think these will remain and will certainly come to the fore in the next year or so, and it's incumbent upon the industry to help find solutions to these.

Tim Smith: Okay. And Peter, your thoughts on this?

Peter Fisher: Yeah, I think I'd say the same thing Gavin did, but maybe look at it from a slightly different angle. I think in the coming year, trustees and pension schemes are going to be confronted with three contending forces. The one is the Bank of England and the path of interest rates, may be higher for longer. Maybe just high for longer. The second is, and that may be making schemes look better funded, but it may also make the markets look more volatile and harder to navigate.

Peter Fisher: And so then market volatility is the second factor. And then the third are these underlying challenges of demographics and consolidation the trustees are going to have to keep their eyes on. So they're going to have to navigate this sort of three pointed set of forces, Bank of England, market volatility and returns out there and then those structural features of ageing population and consolidation. And I think that that's what's going to come to the fore next year.

Tim Smith: And finally, crystal ball time guys. I know, I'm sorry, it's not easy, but looking into the future, which force in particular do you think will have the most impact on the retirement landscape in 2024? Gavin, let me ask you that first.

Gavin Lewis: Again, I know we've spent a long time talking about longevity and demographics, but actually I think it will be the, you know, the structural macroeconomic shift that we've seen. The persistence of inflation on real wages. The persistence of high interest rates and volatility in asset class returns. I think that is the underlying factor which is affecting all these other macroeconomic macro forces. So I would say it's the macroeconomic environment in which we operate.

Tim Smith: And Peter, looking into your crystal ball.

Peter Fisher: When we look back at 2024, I think we're going to see some more volatility events. They may not be as extreme as last year's LDI crisis a year ago, but they're going to feel like that. And when you look around the world you see when central banks leave the rates a little higher as they're going to do, that tends to eventually generate pressure in the markets. And I think trustees will look back at the end of 2024, either with a sigh of relief or a little anxious about how the assets played out over the course of the year, their investment strategies.

Tim Smith: Well, that's it for this podcast. It's been an enlightening and fascinating conversation. Gavin, thank you for joining us.

Gavin Lewis: Thank you for having me back, Tim.

Tim Smith: And Peter, thanks to you, hope you enjoyed your first time on the podcast.

Peter Fisher: I did. Thank you very much.

Tim Smith: Well, join us again soon when we'll continue to look at the key trends shaping the UK retirement market. And do subscribe to this series so you won't miss an episode.

Tim Smith: For now though from me Tim Smith, Gavin Lewis and Peter Fisher, thank you for listening and goodbye.

JINGLE: Here from the How, back soon.

End of podcast.

Risk Warnings

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

Important Information

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons.

In the UK and Non-European Economic Area (EEA) countries: issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: + 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2023 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, and iSHARES are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

JINGLE: PensionShip from BlackRock.

Tim Smith: Hello, and welcome to PensionShip, the podcast from BlackRock for professional investors in the UK. I'm your host, Tim Smith, and in this series we'll be sharing expert insight and opinion on the key trends shaping the UK retirement market.

Tim Smith: Our topic for this episode is the five key forces shaping the future of Retirement. Joining me to discuss this are Joe Dabrowski, Deputy Director of Policy at the Pensions and Lifetime Savings Association. Hi, Joe. Welcome to the podcast.

Joe Dabrowski: Thank you. Hi, Tim, how are you doing?

Tim Smith: I'm doing very well. Thank you for joining us. Also with us, Chris Eastwood, Co-Founder and Co-CEO of Penfold, the digital pension company. Hello, Chris. Thank you for joining us.

Chris Eastwood: Hi, Tim, thanks very much for having me. Great to be here.

Tim Smith: And hello and welcome to Henry Odogwu, Head of Defined Benefit sales at BlackRock. Hi, Henry.

Henry Odogwu: Hi, Tim. I'm looking forward to the conversation

Tim Smith: Yeah, looking forward to speaking with you too. Let me start with you, Henry. The retirement landscape is becoming more complex, impacting clients and members investment decisions and outcomes. So, to start with then, just list for us the five key forces that are at play here.

Henry Odogwu: Yeah, sure. So, the five forces at play that we see really are firstly the new macro regime, secondly a focus on affordability, demographic changes, an elevation of social issues, and last but by no means least sustainability.

Tim Smith: And, Chris, Penfold of course facilitate personal and workplace pensions. What can pension scheme trustees and consultants do to protect schemes from the volatility that we've been seeing recently?

Chris Eastwood: I suppose the first thing to say is that pension schemes have really benefited from a sustained period of benign market activity, which has allowed them to achieve double digit growth year on year with exposure to passive index instruments. I think that should really be seen as the anomaly and not the norm. The reliance on equity and bonds only in portfolios has reflected the uptick in volatility far more acutely than it should have. So, I think going forwards and really a diversified portfolio, including real assets, can help to smooth that volatility. Nothing that's happened in markets recently is that new and should already be accounted for in a well thought out and monitored investment strategy and objectives.

Chris Eastwood: Of course, deviation away from passive funds will have cost implications for members, but you know, with a robust value for money framework most things can be kept under an interact. So, I would just add finally that, you know, this period of volatility should bring to the forefront of stakeholder’s minds climate change, the market shocks and volatility that we've seen recently will ultimately pale into insignificance to what we could see resulting from climate change. So that's where much work needs to be done to prepare portfolios from future risks.

Tim Smith: Okay. And we'll touch on that subject later I know. But Joe, let me bring you into the proceedings now. What do you think are the opportunities for schemes and members that'll come from greater consolidation in the pension sector?

Joe Dabrowski: Consolidation is one of those words that we hear a lot about at the moment in the kind of pension sector. I think it's probably worth just first of all saying that it comes in many forms, not just one. There's, shared services, pooling, moving into master trust, for DB and DC, PPF and buyout, of course, and in those different areas, whether it's LGPS, the DC sector, primarily master trusts, or DB, you see different things at play in the LGPS, for example, the largest funded DB scheme in the UK we see we've had pooling in England and Wales and the consultation that's open at the moment is looking at accelerating some of that consolidation from funds to pools. And then the future evolution of those pools into potentially smaller numbers.

Joe Dabrowski: Equally, we've seen in the Mansion House reform package, government finally really pushing forward on the super funds primary legislation, which creates a new form of consolidation in DB, and in DC you continue to see the rise of master trusts with contract base moving in, and in the background PPF and buoyant buyout markets. So, lots of consolidation in lots of different ways. I think it's probably worth bearing in mind that generally there are some themes across all which are scale and resource, whether that's investment scale and opportunities to invest in new, illiquid, more challenging assets or whether it's having the resource of a bigger governance budget to run the scheme in a different way. And I think one of those big drivers at the moment in the conversations is consolidation in order to get investment into the UK.

Joe Dabrowski: There are different ways of doing that and I think some of that's through also just product sets that might be accessible to all and to all sizes. And amongst all of that, we should probably not forget that small can be beautiful too. There are lots of good small schemes out there. I think from a member perspective, there are also lots of benefits potentially from scale in terms of the member services that can be available, whether that's through more online tools, support at retirement or other digital services, including when the dashboard comes in. So, lots of positives from consolidation, but still lots of different things at play which we need to think about as we move forward.

Tim Smith: Ok, thank you for that. Now, according to the Office for National Statistics, the UK's population is projected to increase from an estimated 67.7 million now to 69.2 million in mid-2030. And the number of older people aged 85 and over is forecast to almost double to 3.1 million by 2045. Henry, when creating pension solutions for different demographics, what key factors do you need to consider?

Henry Odogwu: There's a number of factors there. I think one of the most important ones that we've seen really highlighted is firstly an intergenerational transfer of wealth. So, what does that mean in practice? It means that some younger individuals are saving less into their pension pots, which obviously gives them a lot less pressure to save for retirement given this huge transfer of wealth. The other thing which is getting lots of attention is the accumulation of assets and increasing drawdowns. So, we've seen baby boomers entering retirement and this is leading to a major shift in focus from accumulation and saving into deaccumulation and retirement income.

Henry Odogwu: When we look at drawdowns in particular, we've seen that increase approximately 24% from 165,000 in 2021 to over 205,000 in 2022. And then another thing that plays into that is longevity risk. So, retirement pots need to work harder for longer as retirees are living for longer. But that's something that's often underestimated. So, when pension savers are thinking about their retirement pots, they have less of an understanding of their spending needs into retirement, but also the probability that they're going to live much longer than they expect. So, that also factors into how we design solutions. And a final factor, which I think is gaining more and more providence is when we look at things like the ethnicity and gender pensions gap.

Henry Odogwu: So just a couple of statistics to reel off here. I mean, the average pensioner from an ethnic minority is approximately £3,000 worse off than other pensioners, which represents a 24% gap in retirement incomes. And if we look at the average gap between a female pensioner from an ethnic minority group to a white male pensioner, we're talking of approximately 51%. Indeed, a report from the Pensions Policy Institute states that by their 60s, the median women's pension is worth approximately £51,000, while equivalent for men is more than triple at £156,000. So, again, a number of factors we need to consider when we're designing these solutions.

Tim Smith: And following on from that and those factors. Chris, in the age of the app, how are you at Penfold adapting to changing demographics?

Chris Eastwood: Penfold was created really to build greater engagement and participation in pension saving for everyone, but in particular those in the early and mid-part of their accumulation journey. For whom app based digital experiences are the norm and this population obviously has more time to benefit from compounding, but frankly aren't saving anywhere near enough to be comfortable in later life. And those are three reasons of apathy, other financial priorities, frustration with existing savings platforms. We found that by reducing those frictional barriers to entry and clearly communicating the benefits of pension savings, people can and will increase their savings.

Chris Eastwood: But even though that was the sort of genesis of Penfold, we certainly haven't neglected or forgotten about those approaching retirement who are increasingly looking for a digital solution to help them plan for and access their retirement savings through drawdown. I think if we step back to look at the market, we're obviously experiencing this gradual shift in dependency during the accumulation phase towards defined contribution and retirement solutions need to map that journey. The current thinking and design of drawdown strategies is not really fit for purpose in that new era. So, a solution that looks to exhaust a savings pot is fundamentally flawed. I think schemes need instead to offer tools in combination with DC savings, such as access to annuities, equity release, complementing portfolios with cash generating assets.

Chris Eastwood: There are things like affordable housing. We're seeing a huge increase in build to rent sector, environmental credits such as biodiversity, net gain, carbon credits. All of these things have a role to play in the future of building out a balanced, diversified deaccumulation strategy. And for these reasons, we set up our scheme as a SIPP primarily because it's more flexible and better placed than a master trust to bring that sort of combination of tools together to design drawdown strategies for the future

Tim Smith: There are clearly some dynamic issues at play here. But staying with demographics, Chris, is it something that needs constant monitoring today in a way that perhaps it didn't do ten or 20 years ago?

Chris Eastwood: I'm not sure it wasn't needed ten or 20 years ago, but perhaps it's more in the spotlight today. Some of the statistics that Henry has outlined, we see borne out in the data day in, day out at Penfold where you can clearly see that both the gender pay gap and the savings rate for different demographics. It's been a huge focus on Penfold on engaging these new audiences and helping people with different perspectives or approaches to their finances to engage in pension savings. So, I think a greater focus on the end customer, inclusivity about who that customer is and a reframing and communicating pensions in the most appropriate way to that audience will need to be a focus for everyone going forward.

Tim Smith: Henry, anything you'd like to add to that on the subject of demographics?

Henry Odogwu: Yeah, and I think, again, referring back to one of the things I mentioned earlier, just around the gap between pensions between male and females, I think another interesting stat is the average women's pension is worth 35% less than a mans by the age of 55 in the UK. So, again, we look at these big disparities of outcomes. Another thing that's worth touching on really is the impact of the cost-of-living crisis. Again, you know, we've seen that have a huge impact on people's budgets. Often one of the first things which is seen as a low hanging fruit in terms of saving is reducing pension contributions. But actually what that really does is have a big impact on their longer term outcomes, especially when we think about how returns compound over a long period of time, over a long horizon and a pension.

Tim Smith: Well, Joe, let me bring you in now on that subject. The cost-of-living crisis and the fact that it is pushing pension contributions down the priority list, the Financial Services Contribution Scheme has said that 23% of those with a pension have either decreased their contributions or stopped them altogether. How do you, Joe, see these challenges affecting the retirement landscape generally?

Joe Dabrowski: I think it's absolutely a big challenge across the sector and it's been a big challenge for many people day to day, the full impact of the cost-of-living crisis. The data that we see from our members and also from DWP in relation to the automatic enrolment providers is a bit more positive than the FSCS data, which perhaps includes some more retail customers. Largely that looks like people have stuck with their contributions and not opted out in any great shape, which I think it shows some of the power of the automatic enrolment system. But, more broadly, touching on both the demographic question and the question of adequacy, really, these are big challenges.

Joe Dabrowski: We know from the analysis that we've done with the PPI and others that lots of people are not on track to get an adequate pension in retirement. Those with DB tend to be a little bit older in generational terms, have got a much better chance. So, combinations of the cost-of-living crisis, some of the economic headwinds that we've had over the last five, ten years have really knocked back the question of adequacy and how do we improve contribution rates in particularly in DC in order to ensure that people now saving into AE or who are in that sandwiched generation between AE and tail end of DB, in particular, how do they get a good outcome and what do we do for them?

Joe Dabrowski: We are storing up a problem if we don't address it, but I think we do need to be very sensitive to the kind of immediate pressures that people are under. And so, we need to think about the timescale for how do we improve contributions over what timeframe and what impact will that have on millions of savers who really do need more support and more overall in the end in order to have a good outcome.

Tim Smith: And, Chris, I'm guessing you've seen the results of some of those pressures at Penfold with regard to contributions. Anything you'd like to add to what Joe has just said as to what can be done about this?

Chris Eastwood: Yeah, we have seen it to some extent. I would say it's not as widespread as some of the statistics you can hear more publicly. I think we have a fairly low opt out rate from our workplace pension. It's around 2, 2.5%. And over the last year that's increased to about three, just over 3%. So, we're certainly still well below the national average in terms of opt out rates. But of course, it's a thing that we hear from customers quite regularly that they need to prioritise their short-term financial situation over their long-term situation. And for us, we always just try to get back to education, make sure that people aren't missing out on employer contributions by opting out of their workplace pension. Make sure that's really a last resort in terms of accessing additional funding today. Can they cut expenses before leaving money on the table from workplace employer contributions?

Tim Smith: Well, it's clearly a timely question. Henry, anything you'd like to add with regard to the way that the current cost-of-living crisis has affected pension contributions?

Henry Odogwu: Yeah. Again, I think it's something I spoke to earlier, but really it's the people looking at their budgets and reducing outgoings and sometimes that's been on the pension contribution side, which, again, has a long term impact on the value of those pots. Because when we look at compounding interest and the long-term time horizon of investing in a pension, if you're cutting those payments today, that can have a really big impact on the value of the pot in future.

Tim Smith: Well, finally, members are now more interested in how and where their pensions are invested. We touched on this earlier, 72% of pension savers consider ESG factors important when investing. Can you share the type of feedback that you've been hearing from clients and members about their sustainability concerns? Joe, let me throw that one at you first.

Joe Dabrowski: Yeah, thanks, Tim. Big, big issue. I think there isn't always a 100% conversion rate with what people say in relation to their interest and then how they proceed. But I think it is a key issue for the sector and it's probably worth just taking stock and the fact that the majority of savers now will be in a scheme or with a provider that is either reporting against TCFD or about to, and has probably made a net zero pledge, whether that's 2030, 2040 or 2050. So, majority of schemes and indexes are all set up in order to provide really strong ESG metrics and performance. The strategy is set up around that. I think it has been a big focus of schemes across the sector for several years now.

Joe Dabrowski: We've seen a big tick up in interest around COP, but there was a lot of work going on before that and we saw really high degrees of interest in particular sectors, big DB and the LGBS and DC has caught up over time. So really important issue for lots of reasons, savers interests, but also fiduciary reasons. Sustainability and managing those risks appropriately is a good fiduciary thing to do. You want to be making sure that you've got the right governance in place and the things that you're investing in. The regulatory risk is managed. And also there are so many opportunities in the sustainability transition. People should be thinking about that.

Joe Dabrowski: I think what we've seen over the last decade is a variety of changes in interest around sustainability. Some of that started around corporate governance and good behaviours in those spaces, transitioned through a lot of interest in climate over the last five years and more recently a lot of focus on social factors, including some of those that we just talked about. One of the things that's clearly coming up on the rails and is gathering a lot of interest is biodiversity. We've seen a lot of progress with the TNFD and the TNFD and TCFD reporting frameworks will hopefully converge in a helpful way over time.

Joe Dabrowski: They're reasonably close now, but these kind of big themes of climate, social factors and biodiversity feel like the big sustainability issues of the time and things that we will be grappling with over the next decade in order to kind of really make some progress given against those strong commitments we all made a couple of years ago and continue to kind of revisit every COP.

Tim Smith: Henry, what reaction have you been getting about the challenges of sustainable investing?

Henry Odogwu: Yes, I think Joe's highlighted a number of challenges we've seen as an asset manager, but I think a couple of key things there really are, firstly, as we know, for defined contribution schemes, the majority, I think the last statistic is over 90% are invested in default. So having to incorporate sustainability into a default fund when you're not tailoring it to any specific member, but you're trying to group lots of people together, that's a very big challenge. And again, I think for the managers point of view and again, it's something that Joe touched on, it's just the impact of regulation and reporting, whether it be TCFD or other reports. That's been a huge impact from a manager’s perspective. More broadly, it's become a topic that we're seeing more and more interest in, both from a member's perspective, from an engagement point of view, but also more broadly from as a manager as well.

Tim Smith: And Chris, finally, let me bring you in on that question. Any sustainable pension investment feedback that you'd like to share?

Chris Eastwood: Yeah, I guess just picking up on what Henry said, we also receive feedback quite frequently from our members, from businesses expressing an interest to invest more or pivot the investments more in line with their values. And that's typically the most frequent one is around environmental sustainability and climate change. I think ultimately members rely on the custodians of their pension savings to make lots of decisions on their behalf. Climate change shouldn't be treated differently. I think I would just say that sustainability isn't just a values choice for those members. I think it's a necessity to protect savings from the risk of distressed assets in future.

Chris Eastwood: Companies are being steered through regulation to consider the impact of climate change on their own balance sheets and articulate what they're going to do to mitigate risks. At some points, the changes in corporate strategy could result in a number of shocks that could, with the appropriate strategies, be avoided in portfolios. So, as Henry said as well, the default fund should really be the gold standard of any scheme and we're no different. And that's where 85, 90% of the assets are held and where most of the scheme's members have exposure. Defaults shouldn't just be the cheap option, they should be the most diversified, but also we think the most futureproofed option available. So, that's where we're putting a lot of focus now on evolving our default scheme more in line with values for our members, but also ensuring protection from and futureproofing around sustainability.

Tim Smith: Ok, well, that's it for this podcast and I think you'll agree it was a really insightful and very valuable conversation. Joe, thank you for joining us.

Joe Dabrowski: Thank you very much for having me.

Tim Smith: Henry, thank you also to you.

Henry Odogwu: Thank you very much, Tim.

Tim Smith: And, Chris, thank you.

Chris Eastwood: Thanks, Tim, really enjoyed the conversation.

Tim Smith: Join us again soon when we'll continue to look at the key trends shaping the UK retirement market and do subscribe to this series so you won't miss an episode. For now though, from me, Tim Smith, Joe Dabrowski, Chris Eastwood and Henry Odogwu, thank you for listening and goodbye.

JINGLE: PensionShip. Back soon.

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The future of retirement, the good the bad and the ugly

Tim: I'm your host Tim Smith and in this series we'll be sharing expert insight and opinions on the key trends shaping the UK retirement market. The theme for this episode is the future of retirement, the good the bad and yes the ugly. Joining me are Gavin Lewis managing director, Head of UK Institutional Client Business at BlackRock. Gavin hello, welcome to the podcast.

Gavin: Hi Tim, thank you very much for having me.

Tim: And also Joanna Matthews director at Capital Cranfield the pension trusteeship and governance firm Joanna hello to you welcome to the podcast

Joanna: Hi Tim is great to be here.

Tim: It’s good to have you both here. Any experience in broadcasting and podcasting before now what about you Joanna?

Joanna: None absolutely none.

Tim: But I did think I heard you say earlier that you've been doing some practice?

Joanna: Just to check that my microphone was working so please forgive any mistakes.

Tim: I'm sure it will be fine, what about you Gavin, any experience of this kind of thing:

Gavin: So I must confess that I featured on a number of podcasts and webinars before but don't let that fool you into thinking that I actually know what I'm doing, so please treat me as a complete novice.

Tim: Well, I've done a lot of this in the past and don't let that fool you either. Listen Gavin you and Joanna have produced a white paper on our theme today it's called UK DB Pension Schemes After the Storm, why did you decide to write this in the first place.

Gavin: Essentially there are two elements to the paper, the first is the reference to the storm itself and then there's discussion about what happens next. So the storm that we're referring to really discusses the events that happened in the mini budget of September 2022 and really these decisions, I think, it's not too extreme to say that have radically changed the position of UK defined benefit pension schemes. It's quite interesting that in 2022 the position of pension schemes are changing anyway but it was the speed at which the position of the schemes changed, which was unprecedented. So most of the attention is on the events themselves and what Joanna and I felt is missing from the discussion is, OK this has happened, the position of pension schemes has changed but what happens next because there is a danger that we only focus on those events and we don't actually think about what happens next.

Tim: Joanna anything to add to what you just heard from Gavin?

Joanna: So I think from a pension scheme perspective one of the things that has become clear as a result of what happened in the storm is there are lessons. There are things that's that worked well for pension schemes, there were things that worked less well for trustees so there's clearly some learning points here whether a scheme did well out of the crisis or had some challenges that will help improve governance going forward and it's that, that I think Gavin and I feel is important to share with the industry.

Gavin: And if I could add just one more thing, I was looking at the Pension Protection funds data on pension scheme surplus and deficits and if I recall correctly at the end of March there are now less than 700 UK defined benefit (DB) pension schemes that have a deficit and it's a huge change because before September 2022 I think that number, Joanna, it was something like 1500 to 2000 so it's been a radical radical shift in the position of pension schemes in the UK which means that the vast majority are now fully funded or in surplus.

Tim: What was short term impact of the challenges, like market volatility and indeed inflation, had on pension schemes?

Joanna: Well I guess the background Tim is that market volatility hasn't been a new thing for trustees, we've been dealing with it in in various guises over many years. I think it's fair to say though up until 2022, market volatility was always in the context of falling gilt yields which has been a challenge for trustees because that's meant that our liabilities have risen. What happened in 2022 was that gilt yields rose which on one hand was a great thing for pension schemes liability but caused a headache in the trustees needed to post collateral on their hedging strategies. Now trustees are always modelled for having to do that and and planned for having to do that. I think the thing that was a real challenge in 2022 and particularly September, October was the speed at which those gilt yields rose and therefore the shear amount of collateral, that trustees therefore needed to post within a matter of days.

Tim: OK Gavin looking ahead what do you think the long-term implications of these challenges could be?

Gavin: The first is for an asset allocation perspective because particularly when you think about allocations to illiquid assets previously, I think the average allocation to illiquid assets, so hear we're talking about asset classes such as infrastructure, real estate, private equity and private credit. Allocations probably ranged between 10% on average maybe up to 15 for some schemes that are allocated earlier but because of the collateral requirements which Joanna alluded to and the selling of more liquid assets to fund collateral calls we've really seen allocations become somewhat out of kilter. So we've really seen are more now even overweight illiquid positions for pension schemes relative to their liquid assets, so there's also discussion around what the end game of pension schemes now is because many schemes, before the situation probably would have headed toward will be called a buyout, which is that the risk is transferred away from the sponsor to an insurer. But there were a number of problems with this, firstly those illiquid assets many of the insurers can't take them onto their their balance sheet but if you can't exit them that presents a challenge. And then there's also the problem of actually how do you then get your portfolio in the right shape to allow it sure to actually, actually take it on. The quantum of pension schemes that now want to end to a buyout also potentially creates a bottleneck. I do think that insurers are being very very nimble in the way that they're now moving around the market. I do think capacity has increased but I do think the number of pension schemes that might want it or buy out probably means that they need to think about other alternatives to buy out and that could be for example running on a low dependency self-sufficiency basis or undertaking a buy in.

Tim: Joanna when there is market volatility I mean what should be at the forefront for pension schemes what do professional investors need to consider?

Joanna: I think trustees should be assuming that there will be market volatility. When trustees set their end game strategy which is their journey to buy in buyout or self-sufficiency, often the advice that they receive makes it sound as if they're going to go in a nice straight line to get there and they're going to be getting I don't know 1.5% return above gilts or whatever it is every year like clockwork over the next 10 years in order to reach that goal. The reality is trustees know is that it's not going to be a straight line and so I think those sorts of issues are going to be there for trustees they need to plan for what are the sort of events that are likely to blow us off track and how do we meet those challenges. Equally what are the things that are likely to present opportunities by in pricing for example may have a short term period which is very attractive and trustees need to be nimble in order to take advantage of those as well as to deal with the headwinds. The schemes that manage the crisis well, in my view, were the ones that had a a good delegation structure so that the people on the ground able to take decisions in a matter of hours were empowered to do so without having to go back to the trustee board or the investment committee. If a scheme hasn't got that that would for me would be the key lesson learned from the crisis to make sure that that's in place for the future.

Tim: Do you both think then that sticking with the more traditional investment approach now means higher risk instead of creating more dynamic and as you said Joanna, nimbler portfolios?

Gavin: When we now assess the landscape, we actually see schemes in almost, you know an array of categories and for us, there are three broad categories. So, the first is those that tend to be better well funded and probably entered the crisis in administered strong funding position and with a good sponsor covenant and we see these schemes probably happy retaining risk on the sponsor balance sheet. There is a second cohort, and these are schemes that probably weren't as well funded probably weaker sponsor covenant and I think this is the group that's really wanting to head to buy out all minimise risk from the sponsors balance sheet. They are probably at greater risk of volatility or need to manage it more more keenly maybe because they have a small deficit to cover all they have as we said earlier this overweight to illiquid which can affect performance. But we also have that smaller groups so if you think back to the PPF data there are still circa 700 pension schemes that have a deficit, quite how they then navigate the stormy waters given the more volatile macro economic environment, characterised by yes greater volatility, higher levels of inflation, even though there are higher interest rates is a challenge. How they navigate these stormy waters in this new regulatory and evolving regulator regime and how they do that with the right governance, I think that is quite a challenging task ahead for pension fund trustees.

Joanna: One of the things that I was wondering is kind of what we mean by a traditional investment approach and what has worked well in the past and what how perhaps we need to adapt for the future. One question that perhaps has been asked trustees is well in the light of what has happened it is having a hedging strategy a sensible idea and I think for me the answer to that is a resounding “yes”, it would be a very very bad move I think if trustees decided that they were burnt by the events of last year and decided that they they didn't want to pursue a hedging strategy. Without a hedging strategy in the run up to 2022 many sponsors would have been insolvent because of the ability of the schemes assets to match those of those rising liabilities and so I would hate for trustees to think that the LDI equals bad news because LDI has really been the saviour of DB pension schemes over over the last ten years or so. One thing that I do think trustees do need to be asking themselves now when their modelling what could go wrong or what market movements could be is I think they need to be asking themselves and what happens if it's quick? what happens if it doesn't take weeks or months or years as our models have assumed? What if it takes hours and what if it takes days? Do we have the right governance in place to enable us to make the right decisions rather than for example having to be forced sellers because with not able to move fast enough? And we've asked ourselves that question in relation to LDI you could apply the same examination of any scenarios that trustees are likely to face, any movements in markets I think we should be asking ourselves and what happens if it's quick?

Tim: OK well to round off then an looking at how pension schemes ensure they are ready to meet their obligations. It's a big question I know but what's the outlook for the future of retirement the good the bad or indeed the ugly?

Gavin: I think there is a huge opportunity for us to ensure that the pension scheme members are able to retire you know helpfully and soundly. I do think that that requires innovation however and I do think that what might have worked before we need to think about how that evolves. So it is something that I would and we are urging the industry to do and we obviously thinking about is how do we what is innovation that like in this sphere. So that is innovation around actually but the end game solutions from an asset allocation perspective but also exiting and reallocating illiquids and from Joanne's perspective as she said that innovation is actually from a governance perspective is actually how do you move more nimbly.

I also think this is a question about the broader pension retirement system and I do think that you know if you're the recipient of a DB pension scheme it's good news for you, I do think that then makes us turn our attention to DC pension schemes and how do we get individual savers because they don't have the support all the sponsor covenant DB pension scheme does about the individualization of risk. The question now I think is that how do we get better outcomes for individual DC members bearing in mind that they are still subject to the same forces that DB pension schemes are subject to and that might be higher inflation, higher interest rates and greater volatility in this very new macroeconomic regime. If the industry can innovate which is what we are known for then actually, the good the bad and the ugly, actually feel quite positive about what we can do but it will take a concerted effort across all market participants.

Tim: OK staying positive then Gavin. Joanna the outlook for the future of retirement good bad or ugly?

Joanna: So I agree with Gavin I think that members of our defined benefit pension scheme are largely in a good place and their members are pretty much on track to receive what are compared with perhaps defined contribution members pretty generous benefits. I think the challenge is for defined contribution members, do members have the appropriate information in order to make informed investment decisions. Decisions about the appropriate level of contributions that they need to make, when might be every at realistic time for them to retire all of those questions I think the industry needs to really take as a challenge to to help members to be able to answer those questions for themselves in a world when perhaps what we assumed the investment outlook was may now look very different and how we can we stay on track with that.

Tim: Well that's it for this episode I think we managed to cover an awful of ground there thanks very much indeed to both of you for such an interesting conversation Joanna thank you really nice to meet you.

Joanna: My pleasure Tim lovely to meet you too.

Tim: Gavin thanks very much indeed.

Gavin: Thanks for hosting.

PensionShip - Private markets: in turbulence find optimism

Tim: Hello and welcome to PensionShip the new podcast series from BlackRock for professional investors in the UK I'm your host Tim Smith and in this series will be sharing expert insight and opinion on the key trends shaping the UK retirement market. Now our focus for this episode is on how private markets can find optimism in turbulent times. Joining me to discuss that from BlackRock are Claire Felgate, Head of Global Consultant Relations UK, hello Claire welcome to the podcast.

Claire: Hi Tim, thanks so much for having me.

Tim: And Dom Byrne, Head of DC strategy in the UK, Dom welcome to you.

Dom: Hello Tim.

Tim: We should say, straight away that you two have known each other fairly well, indeed you've worked together for some considerable time is that right Claire.

Claire: Yes, it actually makes me laugh because as you said that what pops into my mind was for better or for worse, and it feels like Dom and I have been together in a marriage of minds for over 11 years. We've both been at the firm for a really long time, and it's been it's been an absolute delight Dom, in our various roles at BlackRock.

Dom: Thank you Claire. So long time working together lots of fun on the way not always talking about pensions so we just had the very interesting conversation about the pros and cons of camping with children and we’ve had many discussions around our favourite lunch spots across the city, so great to be here with Claire, great to be here with Tim.

Tim: So let's turn to professional investors then indeed it professional investors in the UK currently facing both challenges and opportunities of course. Let's get under way by getting both your insights into the factors that are driving the allocation of funds to private markets, Claire let me start with you please.

Claire: One of the biggest drivers is the potential for higher returns that you get in private markets and particularly also opening up that opportunity set of investments. The second area that we see ready is to enhance portfolio diversification particularly you know we've seen a lot of volatility in markets recently and having that diversification can really benefit a portfolio overall. The third thing is protection against inflation you know I think that everybody is well aware of the high levels inflation that we're facing not just in the UK but also globally and so having assets that help protects against that inflation in your portfolio is really important.

Tim: OK moving to you then Dom your thoughts on this?

Dom: Sure so I think in the DC market what we're seeing is we're growing and also we're seeing a smaller number of schemes as those assets grow in the market consolidates and what that look does is it basically means we're looking over our shoulder and say well what are our the larger institutional cousins doing in other markets globally but also here in the UK and that inevitably leads to the adoption of private markets which is a global trend for large institutional investors. Secondly like any other investment profile or investment scheme, DC schemes were trying to make the best they can from the opportunity set to meet their objectives. And the objective of a DC scheme puts in place to grow savings then convert those savings into retirement income so that means investment returns as Claire mentioned a super important and also taking age-appropriate risk. I think that's when we started digging little deeper into the private market complex so if we take private equity important asset class, the largest private market asset class available to us and also really attractive from a growth perspective particularly for those long-term investors very different some of those income focused private markets that are DB scheme might look.

Tim: Claire, explain the influence that the different objectives of defined contribution and defined benefit pension schemes have on driving allocation to private markets?

Claire: DB schemes have been around for a long time and are much less available to current employees whereas DC schemes are our kind of standard mode of saving for retirement at the moment. The important piece about that, is that DB schemes have a different time horizon and so many of the DB schemes that we work with have a shorter time horizon, they know what liabilities they need to pay and that really drives allocation that they have to private markets. However, on the DC schemes, these tend to be nascent or younger plans with members that have a much longer time horizon and a much greater need for growth and so that drives a different kind of allocation for DC. But in DC we also face a couple of other factors and one of these is that DC schemes have really struggled to gain access to private markets because of the implementation requirements. What we have seen more recently is private markets growing in popularity for DC and there's been quite a big move forward in the industry particularly being supported by the LTAF which is the long term asset fund. In order to make private market investing more accessible for DC members and so we're really excited about this opportunity for DC schemes to be able to invest and I think really you know that's one of the biggest trends that we're seeing in that marketplace.

Tim: Well Dom let's look now if we can at some of the risks of private markets since private equity investments don't of course trade publicly, is liquidity risk the main one would you say?

Dom: Liquidity risk is very very important. For a DC scheme, the investment time horizon that we've mentioned here is multi decade so you could argue that liquidity risk is potentially overstated. Many members will have been a long time to contribute any to pull the money out. Secondly DC schemes we call cash flow positives that basically means the money coming into the DC scheme exceeds the money coming out at any given time. So these are things that might think, well actually let's not consider liquidity risk as much as we might do for other types of investments, but we know that the DC dynamic is different. We need to think about things like the regular contributions that come into DC schemes offering the ability to put those contributions to work on a regular basis, so regular liquidity is helpful and then also schemes will be balanced they'll have to get back to their target weights they'll often the risk as they get closer to retirement so again other demands for some structural liquidity. So what we don't want to do is make illiquids liquid we want to be able to match the underlying investment liquidity with the overall liquidity of the structure that gives us access but we do want to make sure that there is some structural an open-ended component to the DC vehicle which will help facilitate the platforms, the schemes, and the default manager to ensure there is appropriate level of governance and also the appropriate level of building and maintaining that private market exposure through time.

Tim: Claire your thoughts on the risk factors, clearly lots to talk about.

Claire: Thinking about both DB and DC, one of the things that I would say and of course I would because I work for an asset management firm, but the manager that you choose to partner with is really important in helping to manage these risks and so three of the further risks that we often think about as funding risk, operational risk and also the clients understanding of the asset class. So, if we think about for example funding risk for DB this is around the timing of capital calls and I would say most DB schemes are quite sophisticated and between the trustees and the consultant and the manager those capital calls are typically quite well managed. However we did see, you know, in the gilt market volatility last year, there were some capital calls which you know may have been a bit awkward timing etc for that DB scheme so it's definitely something to be aware of.

When it comes to DC the way that we would look at structuring and alternatives product would be to remove that funding risk as it's much harder to manage from a DC perspective. Moving on to operational risk this really sets a lot with the manager in so doing due diligence on who you choose to invest with is really important and then the last risk is really understanding the asset class and I think traditionally DB has had more exposure to private markets and so inherently has many years of gaining that kind of deeper understanding.

Tim: Staying on the subject of private markets, they're now evolving to reflect the importance of ESG issues so how are they building the right strategies to focus on what's most important and indeed to meeting the expectations of the investment community?

Dom: So, sustainability in the low carbon transition now will present both significant investment risks and opportunities for years to come and I think that really crystallises the approach for private market investments, it's about how does the private market investment manager manage those risks and how do we capture on those really exciting opportunities that private markets can unlock particularly within that sustainable lens. I'm going to give you a couple of examples of how that might play out in different types of private market investments. So infrastructure a lot of our infrastructure investments will think of decarbonization as a specific theme that drives the investment approach but also determines the opportunities that we will conduct due diligence on. So again it's an opportunity theme that's really important for property managers can ensure that investments have a decarbonization plan for both the construction and the steady state of projects but they can also support that through robust metrics to measure those risks. The other thing as well they can do things like project level tenant engagement campaigns to encourage greater focus on these type of issues.

If you move across then instead of this is a real sort of integration example in private credit things that we call ESG margin matches that basically on a best effort basis include things like financial incentives that improve disclosures and also ESG targets particularly for reducing carbon emissions, give that example of how you look very closely with a specific deal to integrate some of those considerations. So it's really not just thinking about holistically, the sustainability of private markets but going one level deeper and understanding how it can be applied to each of the different asset classes that you might think about as you're building your private market exposure.

Tim: OK thank you for that Dom and Claire bit of crystal ball gazing from you now please not easy I know given the current financial climate but what's the outlook do you think for private market investments over the next few years?

Claire: The good news is that being a first-time private market investors, if we think about our DC clients where there's a lot of interest in private markets, this could be a really really good time to build up your private markets portfolio over the next 18 months because we think we're going to see fantastic opportunities. In private credit, I think that this is going to continue to expand and this is obviously also good news for DB pension schemes where there's a real thirst for private credit assets. So we see this continue to expand as the public financing retreats and more companies continue to see capital in this new world. When we move on to infrastructure, our expectation is that this will benefit from the continued investment in sustainable energy and energy security as you know Dom was just mentioning. And in private equity as we see these lower valuations increase buyouts, carve outs and M&A activity. We also expect to see more quality portfolios come for sale in the secondary market. And finally in real estate we see valuations resetting in response to changing tenant demand and also higher financing costs. So this is leading to returns among the different regions sectors and property types and again this will pose opportunities for investment in private markets.

Tim: OK finally when UK markets are in such uncertain and turbulent times can private markets aim to deliver resilience and positive outcomes for pension investment portfolios?

Dom: Yes, I think it is that long term structural investment that clients can consider. We’ve mentioned long term a couple of times today but I think it's it's really important and then understanding that starting point so for investors that are beginning that profile, unlocking those long term opportunities that private markets can offer. I think as well, the themes that we're talking about today that can be exploited both in public markets and private markets, but I think in the private market complex it's that complementary ability and that ability to access some of those untapped areas that aren't well covered by the public markets that make them particularly appealing. The final thing if you think about what's happened over the last few decades you've had this low rate environment that's been very positive for risk assets and I think the narrative around private markets has been around the yields or the return premium relative to public markets. But I think when we look forward we think that private markets shouldn't just be considered on that basis but they should be considered for their active and their additive nature. That means the strength of the asset allocation that Claire has just talked about the ability to construct robust portfolios. I do agree with Claire in that some of the most important things about private markets are the ones that are most often overlooked and that means the quality of the structuring, the robustness of the operational model, but also the sourcing capabilities that are so valuable in terms of not only driving how we set out the private market allocation but how we build and maintain that overtime to continue to eke out those returns.

Tim: And Claire, your thoughts on delivering resilience and positive outcomes for pension investment portfolios?

Claire: Thinking back over the last ten years we've been in this period of great moderation which was essentially at that saying of a “rising tide floats all boats” were now in that period of time where the tide goes out and as they say in financial services that's when you get to see who's been swimming naked and so I would really just reiterate what Dom was saying is make sure that you're partnering with the right manager somebody has deep expertise not just in selecting private markets but in all of the other areas that help to deliver and that manager will help you navigate these sort of tricky but exciting times we see ahead.

Tim: OK well that's it for this episode thanks very much indeed to both of you for such an interesting and indeed of course enlightening conversation. Dom thanks very much indeed for joining us, was it OK for you?

Dom: It was a pleasure and really enjoyed it thanks very much.

Tim: And Claire hopefully it was OK for you too

Claire: Yeah that was brilliant. Dom and I are going to set up a separate podcast on camping with children.

Tim: Well I’m free to host it guys if you need a host!

JINGLE: PensionShip from BlackRock.

TIM SMITH: Hello and welcome to PensionShip, the podcast series from BlackRock for professional investors in the UK. I'm Tim Smith, your host, and in this series, we'll be sharing expert insight and opinion on the key trends shaping the UK retirement market. This time we're looking at the effect that sustainability concerns are having on pension schemes. 

TIM SMITH: Joining me to discuss that are Tim Hodgson, Head of UK DC Platforms and Retirement Solutions at BlackRock. Tim, hello, welcome to the podcast. How are you?

TIM HODGSON: Hi, Tim. very well, thank you.

TIM SMITH: Well, also joining us is Clare Reilly, who's the Chief Engagement officer at PensionBee, an online pension provider. Clare, hello, welcome to you. Thanks for coming on the podcast. Are you ready and raring to go and do you have everything prepared for us fully?

CLARE REILLY: I do. I do. Thank you for having me. Nice to be here, Tim and Tim.

TIM SMITH: Well, nice to have you both on the podcast. Tim, let me start with you then. Sustainability, I guess now more prominent on the pensions agenda than ever because of factors including changing legislation and growing demand from members. Can you set the scene though first Tim, in terms of what the markets have been seeing over the last five years?

TIM HODGSON: I mean, it's unquestionably been one of, if not the main topic of conversation over the last five years. It was a peripheral concern for most people five years ago, it's absolutely now a minimum requirement for pension schemes to be considering and acting off the back of those considerations. 

TIM HODGSON: So I think we've seen that as a result of member demand. So individual pension members. But I also think we've seen regulatory pressure and we've seen product evolution happen to support that. I think actually if you look at the data, there's something like 80% of scheme members are now in pension schemes that measure and publish how they support the Paris Agreement. And I think we've also got something in the region of 85% of schemes now covered by carbon commitments. So really that has consequences for all of us, but mostly for us and along the lines of transparency, reporting, quality and product innovation.

TIM SMITH: And Clare, what have you been hearing from your members about their sustainability concerns?

CLARE REILLY: We gather the views of our customers on a regular basis. We do that through annual surveying. We've actually been running an annual survey of customers in the tailored plan, which is our default plan, which is BlackRock’s Life Path and has about 80% of the customer base. For four years now, I think we've seen much more interest in the S. Specifically, we've heard some very strong views from customers on the companies and their pension paying a living wage. You know, for most people profit at the expense of harm to society is going to be a clear no. Same for closing gender pay gaps, people feel strongly about that.

CLARE REILLY: Over the last two years deforestation and biodiversity loss have increasingly been sort of cited as the primary concern of respondents in our survey across all genders and age groups. And interestingly, the one topic we've seen views only shift a small amount on over time is fossil fuels. So every year we ask the same question in the survey, which is, what is your view on the oil industry and should your pension continue to invest in these companies? So it's quite interesting when we look at the kind of response breakdown we've had over four years.

CLARE REILLY: So 25% of customers who are answering that question are sort of resolute that they want to stay invested in oil and gas. It brings them good profits. They don't want to see it removed. Around 45% want to continue to invest in oil and gas on the basis that those companies are genuinely committing to net zero and are genuinely trying to minimise their impact on the environment. And then the last group that want out, this number is slowly going up, but in 2020 it was 15%, in 2023 it's gone up to 21%. So I think interestingly we are seeing that people do have views on fossil fuels, but they don't always necessarily take action.

TIM SMITH: Well, following on from that though, Clare and staying on the subject, I mean PensionBee has a fossil fuel free plan now and this year has also seen the launch of the impact plan created in collaboration with BlackRock. So how do these initiatives help meet your member’s needs given what you've just said that clearly some of those needs are very different.

CLARE REILLY: We have about 10% of the customer base in a sustainable option. So again we have within that group a real mix. There are people who are leaving a default for the first time to sort of explore their climate concerns and start this journey of sort of matching their pension to their worldviews, to supporters of Extinction Rebellion who are in there as well who we talked to through surveying. So you know who also struggled to find investments that match their views. 

CLARE REILLY: So even in 2021, we were hearing from customers that you know, fossil fuel exclusionary approach, the approach of just excluding fossil fuels was not going far enough. And so that's when the impact journey began. And you know, that's the journey we went on with BlackRock to take an idea that customers want to be doing more with their money. They want to see their money having impact on the world around them, to where we got to with the launch of the impact plan earlier this year, which is you know something that's really different to anything else on offer.

TIM SMITH: So given what Clare has just said, then Tim, and clearly there's a growing interest in the subject of sustainability, how are BlackRock responding to sustainability becoming more mainstream in DC?

TIM HODGSON: Ultimately, at BlackRock, we're a fiduciary. Our job is to listen to clients like PensionBee and their members, but also other schemes and other pension schemes across the industry and really help them navigate this journey, which is increasingly complex, right. So as focus has grown over the last five years, so the complexity and the number of options that you can choose has grown.

TIM HODGSON: So I think we really we're here to help them navigate that and that means helping them capture the opportunities of the climate transition, it helps manage risk of some of the changes we're seeing across ES and G to Clare's point. So our job really is to understand the ambition of each client, of each pension scheme, of each pension member to some extent, and their investment objectives and then to deliver the best risk adjusted returns we can within the mandate that they set us. 

TIM HODGSON: And I think as part of that it's incumbent upon us to kind of deliver better research, the best research in the industry, the best data in the industry, the best analytics so people genuinely understand what it is they're making a choice between and what it is they're trying to achieve. And then how they're doing against that objective? And I think as the kind of focus has increased across the marketplace on this conversation, that understanding of impact I think is genuinely important.

CLARE REILLY: And can I just jump in there, on the ambition point, because actually it's something that really came through in the impact plan focus groups, was this elevating ambition point. And this idea that, you know, we need to always be pushing forward and showing people what is possible with pensions and showing people that you know there are these innovations out there that can be used to sort of give a sense of agency that is lacking at the moment. So you know I think we see our role as sort of elevating ambition as well to keep driving the market forward in that sense.

TIM SMITH: Well, moving things on slightly to a slightly different focus, Tim, as the sustainability landscape evolves and as you've said, it's a complicated evolution at the moment, how much will regulation be a driver for change, do you think?

TIM HODGSON: I think regulation has been almost a key catalyst in the pension landscape. So if you go back to 2019, the kind of requirement for trustees to explain their view of sustainability and what their beliefs were as a trustee group, was a crucial catalyst in making people engage with this subject. And then I think the requirement in 2020, a year later, to show what they've done on the back of that belief was a genuine kind of catalyst for change. 

TIM HODGSON: I think what we've seen more recently and when we look forward is that the environment now whether it's, you know, whichever regulator you choose, the focus is very clear on needing to have a view on sustainability. So I think the Pensions Regulator argued a couple of years ago, you know, if trustees fail to consider risks and opportunities for climate change or fail to exercise effective stewardship then they face the risk that performance will suffer. And at the end of the day, you know that's what we're here to do. We're here to deliver people the best pension we can deliver them whilst taking sustainability into account. 

TIM HODGSON: So I think we've got new and more regulations coming. I think the reporting standards requirements in the Pensions Act 2021, whether it's, you know, and I apologise for the jargon, but TCFD reporting to the task force on climate related financial disclosures for schemes above £5 billion. There's a huge amount going on at a regulatory level. What I would say is if it was an instigator in 2019, it's very much sitting alongside the appetite and the trend of people engaging with this subject. So I would say it's a partner as much as a driver to the changing market environment that we're seeing.

TIM SMITH: And can I just say, Tim, this is probably a subject that requires some jargon and I think you've done very well so far to keep the jargon to a minimum. Clare coming back to you what will members and society’s role be then do you think? And you've touched on this already, but what will their role be overall in the evolving sustainability agenda in relation particularly to pensions?

CLARE REILLY: It's about building trust, I think, because, you know, there is still mistrust and wariness of green washing that comes through a lot when we talk to customers. And making sure that the products that they're investing in really do what they say on the tin. So I think the jargon that we just had, you know, add some more to it. So we've got TCD but coming along soon we will have the financial conduct authorities sustainable disclosure regulation which is going to give additional certainty to consumers around sustainable investing that they didn't have before. 

CLARE REILLY: We've also got the consumer duty and all of these things are going to build trust and structure, I think to the sector. We think voting choice is actually going to be the next kind of frontier for members and society when we're thinking about developing this sustainability agenda. So voting choice is the ability for customers to have their voice translated into a vote through their pension. So that's, you know, fantastically exciting and I think a real chance for us to drive change through pensions.

TIM SMITH: And Tim, what are the emerging trends you're seeing about how investors are responding to the challenges?

TIM HODGSON: We've increasingly seen over the last 18 months, 2 years a real view at the top level of the portfolio. So what is a member's portfolio trying to achieve from a sustainable point of view? And I think that has consequences not only for the building blocks you choose, so which asset classes you choose. I think it has a general kind of consequence for portfolio construction and asset allocation. 

TIM HODGSON: And I think you know understanding that is a huge part of the journey we're on at the moment. And I think that there's a number of reasons why that's the case, right? You know, we're trying to align the long term horizon of pension investing with the long term consequences of sustainability and climate change. And so understanding risk adjusted returns, understanding the demand for participants is crucial. 

TIM HODGSON: We're seeing the proportion of portfolios that are integrating ESG related data is rising. We've seen the number of alternatives for replacing, for example, an equity index increasing, so you know you have different ways of implementing and getting to your end goal. We've seen the number of asset classes that are usable and you can replace regular market cap indices increase, so the likes of fixed income is now, you know absolutely an opportunity to go greener. And I think now in DC in particular we're seeing private markets being a way to play advance sustainable trends. So I think it's really the trend is products evolving to deliver choice to the members and the trustees to hit the objectives that they ultimately set out to.

TIM SMITH: Investment stewardship has an impact on the sustainability transition. Tim, how does this fit with your broader purpose?

TIM HODGSON: You know at BlackRock, we have the largest stewardship team in the world in the asset management community and we believe it's our job to have constructive long term focused engagement with the companies that our client’s money is invested in. 

TIM HODGSON: Now another part of our mission at BlackRock typically is, you know, we believe in the democratisation of investments, making more investment opportunities available to more people. Pensionbee were one of the first clients to ask us to have their own views expressed or their client’s own views expressed through voting choice when we vote on underlying companies that we own. And so part of our journey has been to you know offer choice about how stewardship takes place.

TIM HODGSON: So our stewardship team will engage with companies and we will vote BlackRock’s view on those companies when appropriate. We now have voting choice, which was an industry first actually, and it enables institutional clients to participate in voting decisions. So opening that option up to allow people to have their own views expressed was really important. And ultimately you know BlackRock are committed to a future where every investor can participate in the shareholder voting process if they want to and I think that's a really important caveat.

TIM SMITH: Okay. Thank you, Tim. Finally Clare, then looking forward generally what's key to your business and its members in responding at the moment to sustainability concerns?

CLARE REILLY: What's key to our business is to keep listening and to keep amplifying those customer voices back to BlackRock and ensuring they're reflected in our product or service, in our plans and pushed out across mainstream media and the industry where we can because you know, ultimately we all need to be moving in the same direction on this. Regulators, asset managers, pension providers, society. 

CLARE REILLY: I definitely think we've, you know when we look back at how far we've come like we are all starting to now move in the same direction. So just continuing to stay responsive, I think to changes in society, which can be swift. We live in very uncertain times, but ultimately you know we're in the business of happy retirement. So you know the vision at PensionBee is that everyone has a happy retirement. So we all share the same concerns that we have about the future of planet and society as well as pot. 

CLARE REILLY: So just staying true to the vision and making sure that the plan range is building the kind of safe, healthy and harmonious future that we all share. So that's the vision I think, and we mustn’t lose sight of that.

TIM SMITH: Okay. Well, thank you very much indeed. It's been a really interesting conversation. Clare, thanks very much.

CLARE REILLY: Thank you. It's been an absolute pleasure.

TIM SMITH: And Tim, thanks to you as well. 

TIM HODGSON: Thanks, Tim. Thanks, Clare. It's been great.

TIM SMITH: Do join us again soon please when we'll continue to look at the key trends that are shaping the UK retirement market and do subscribe to this series that way you won't miss an episode. 

TIM SMITH: From me Tim Smith, Clare Riley and Tim Hodgson, thanks for listening and goodbye.

JINGLE: PensionShip, back soon.

End of tape.

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