RI Interview: NEST’s CIO Fawcett on investor collaboration, engagement and climate change

How the UK’s new low-cost DC scheme sees the world

NEST, the new low-cost UK defined contribution workplace pension scheme, currently holds a modest £180m in assets and has only being investing for three years, but it is already has a seat at the table with some of the largest UK pension funds and is engaging regularly with large corporates.

Its clout is expected to grow. While tiny now, it is set to become one of the largest pension funds in Europe. It was set up as part of reforms under the Pensions Act 2008 – meaning UK employers now have to provide their UK workers with access to a workplace pension plan. To ease the process the government helped set up NEST, which is under obligation to take on any UK employer. In April 2014 NEST announced that it had over 1m members saving in the scheme.

Its chief investment officer is Mark Fawcett. Before joining NEST he was a partner at boutique investment manager, Thames River Capital, and has held roles at Gartmore, where he was head of Japanese equities and American Express Asset Management International, where he was chief investment officer.

Speaking recently at a Financial Reporting Council conference on long-termism, Fawcett told the audience that NEST planned to take responsible investment very seriously, but wanted to make sure it didn’t overreach itself.

Expanding on this with RI, Fawcett explains it wants to ensure that its responsible investment activity is proportionate and good value for members, so it often engages in coalition with other pension funds.

“We are part of a coalition that talks to the FTSE and to the London Stock Exchange regularly. For example we got free float rules changed to improve corporate governance across the market,” he says.

“But are we going to take the position of a large activist investor that can go in and get places on the board? Trying to do that would be a waste of members’ money as we are just too small to do that, as we grow and our influence grows we will use it appropriately to get a better outcome for our members.”

The coalition, which is informal, includes USS and Railpen. NEST was asked to join as it is prospectively large. It works with them on a number of responsible investment and ESG issues. Fawcett says this is important as NEST primarily holds the market – its default fund for members uses index-linked funds to access equities.“It’s really important for us that standards in the market improve, not just for individual companies to do better so we’ve discussed things like the free float rules on the FTSE.”

NEST says its membership of the PRI also informed its decision to join the group. “There is a commitment to work with other fund managers,” says Fawcett.

NEST also engages independently with companies. It uses Royal London Asset Management as its partner on responsible investment. It has worked with them on talking to chairs of audit committees at UK companies to discuss things like the quality of audit and rotation of audits.

Fawcett says it is interesting that a lot of feedback from chairs is that they have been the first person to speak to them about it.

Fawcett says NEST has also engaged with chairs of leading banks in the UK to talk about business ethics and how they are looking to change the culture so there is not a repetition of things like the LIBOR scandal.

“We are small,” says Fawcett. “And have very small holdings in companies, but because NEST is becoming increasingly well-known brand in the UK we can have meaningful engagement.”

Though NEST is a passive investor with a number of index funds it puts a lot of importance on engagement.

“We hold all these shares, we can’t sell these shares so it’s really important that companies exercise best practice.”

He says UBS, its manager for its global equities in most of its funds, has a very active corporate governance team. “They engage with companies and we discuss with them on issues that we are concerned with. They report to us and to our investment committee on their engagement and voting.”

He continues: “We are very interested in the value of the shares and by having good corporate governance practices and ESG risk management that will help the value of the shares we include in our investments.”

It has also agreed with managers of its default funds that once it is large enough it will carve out its assets and be able to have a direct say over votes. Fawcett says: “With UBS for example, there are not many issues on which we differ. Whether we implement it on an exception basis or take up overall voting is one of the details that we’ll work out. It certainly gives us a little bit more flexibility and we think it’s good practice.”

NEST broadly looks at four ESG issues – business ethics/corporate culture, pay, governance and climate change. Its integration of ESG goes beyond equities. For example in its UK commercial property holdings it expects managers to invest in sustainable buildings or improve the sustainability of buildings. “This isn’t just about climate change,” Fawcett says. “There are also immediate economic benefits.”

Alongside its default funds, NEST has a series of other fund choices. It has an Ethical Fund managed by F&C Global Asset Management and a Sharia Compliant Fund managed by HSBC Global Asset Management.

Take-up of these funds are currently very small, 99% of its members are in the default fund. But Fawcett expects that demand for the ethical fund, and other similar funds will increase over time as people get more engaged.

He says the ethical fund is very different from the majority of similar products: “It’s not just investing in equities, we’ve got ethical corporate bonds, we’ve got sustainable real estate and we’ve got government bonds. So we’ve got a properly diversified mixed-managed fund.”

Perhaps strangely, one of the top holdings in its ethical fund is Apple – which has had criticism over the treatment of staff in its supply chain. Fawcett says he is confident F&C has a clear and strong process to determine ethical investments.

But he concedes: “While it is not my job to second-guess what F&C are doing, we were very interested in Apple because there had been a lot of media coverage.”

NEST approached F&C about it and it explained that its rationale was that it had engaged and they were very clear that Apple had gone from “laggard to leader” in terms of improving its supply chain and workers’ rights.As for climate change, Fawcett notes: “We’ve done a lot of research on climate change, stranded assets and carbon pricing. We did a big study talking to the scientific and financial community. Not surprisingly, NEST’s approach to the issue is engagement.

“So the financial markets horizon in the next two to three years is maybe stranded assets. Even if it is going to happen according to the scientific community we are 20,30, 40 years out.” He continues: “I think our view is that stranded assets are more likely to be stranded by technological advance than by a fair price of carbon or government saying that you can’t take anymore out of the ground.

“Stranded assets is real – in the US a lot of coal assets are becoming stranded because of fracking. But it is technology that has allowed those assets to become real. We need to understand how Exxon is going to mange itself through those technological changes and transform themselves as companies over the longer term – we will continue to monitor.”

He concludes. “In the short term, excluding oil companies it not really an option for us and we don’t think it would be a good investment decision for us either. “

Nevertheless, it is putting a lot of work into climate change because of the young profile of its members. One of its largest employers is McDonalds, who traditionally have a younger workforce.

“We know for the foreseeable future we will have a younger membership,” he says. “So we have to think about the long-term. That’s why we’ve put in a lot of work already around climate change. But we are not going to make knee-jerk responses by just selling oil companies. We will make very considered moves as we get larger over time.”