The UK’s largest master trust has often led the way for DC investment in private markets. Rachel Farrell speaks to Alastair O’Dell about its investment strategy, strategic partnerships and future plans
As it sails past its latest milestone of £50 billion AuM, Nest is in an enviable position. The leading UK master trust’s young member base means it will be cash flow positive for perhaps decades, enabling it to invest with a long time horizon. It is putting its ability to capture illiquidity premia to good use with perhaps the sector’s most ambitious private markets programme.
Rachel Farrell is Nest’s director of public and private markets. She has spent over 30 years in investment management, including a decade at JP Morgan Asset Management that culminated in her role of CEO and country head of Australia.
Nest was set up by the government in 2010 to ensure there was always an option to absorb the contributions resulting from auto-enrolment, but has always been an entirely independent.
It started to increase its capacity to invest in private markets, beyond real estate, in 2019. In February this year it become the first international co-owner of IFM Investors, with the aim of building new capabilities. “We work with a tight group of managers in large-scale partnerships and are always looking to strengthen our relationships. These will all continue to grow, with IFM as an additional partner,” says Farrell.
Private markets already account for c.15% of Nest’s AuM and it is planning to double this to 30% by 2030 – far outstripping the Mansion House Accord’s benchmark 10%. “A healthy proportion in private markets is a good way of boosting returns, achieved by giving up liquidity we don’t need,” says Farrell.
Nest’s portfolio construction strategy is based on five building blocks: higher growth, long-term stable growth, income seeking, capital preservation and longevity protection. Each block allocates to private markets in line with its objective, from its private credit, infrastructure, renewables, real estate, private equity and timber mandates. The building blocks are then combined to create the funds that members ultimately invest in.
Strategic partnerships
IFM Investors had been entirely owned by Australian superannuation funds before the deal. “Nest has a lot in common with supers in terms of its construction, large pool of capital and centralised default fund. They have been extremely successful, so we look to them as similar entities 20 years ahead of us,” she says.
Nest was seeking a likeminded partner that was keen to collaborate, says Farrell. “IFM’s culture is aligned to asset owners and it’s a best-in-class private markets manager. It is very willing to design investments for us and co-create products.”
Nest is focused on investing with IFM in Europe, the UK and the US. “IFM is very interested in building its footprint – it has offices in London and NY – and doesn’t need us in Australia,” she says.
IFM also benefits from Nest supporting its continued expansion. “We’re well connected in the UK, with good relationships with the Government and market counterparties. We could provide capital for certain strategies they would like to build,” she says.
Being able to offer a permanent and growing source of capital means we’ve been able to negotiate very attractive fees.
Rachel Farrell, Nest
Nest’s ambitious plan to double its private markets allocation will entail a mix of new mandates. “We’re looking at where we want to add exposures, and where it makes sense for IFM to build products for us,” says Farrell.
To complement Nest’s existing investment grade (IG) infrastructure debt exposure, in May the first result of the IFM partnership was a £450 million sub-IG infra debt mandate. “IFM has a very strong capability, so it was a perfect area for us to start working together,” she says, noting it also complements its private credit exposure.
Nest is now assessing whether to also collaborate on private equity. “IFM has a PE growth capability in Australia, which it may globalise. It may make sense, for IFM and us, to work together.”
While Nest’s scale makes it particularly attractive to IFM, other UK master trusts could also become shareholders. Farrell says Nest is “very open” to others joining and IFM remains interested in building and commercialising new capabilities.
Private market experiences
Nest started investing in private credit in 2019. It then allocated to infrastructure and renewables, followed by expanding its direct exposure to property in a “very successful” partnership with LGIM, and added private equity almost three years ago. “The experience has been good. Everything has performed well. But it’s too early to draw any huge conclusions,” she says.
That said, Nest has clearly benefited from diversification. Its renewables allocation was a “great” addition to the portfolio, she says. “When we had the inflation spike around 2022, it worked extremely well as a diversifier. It held up extremely well when other things didn’t do as well.”
Likewise, as private credit is primarily floating rate, it has been a “nice diversifier” to fixed income. “When rates spiked, the floating rate portfolio was resilient.”
Nest has also learned from its experience. “We’re building expertise internally to become a better partner, better understand what managers do well and where we could benefit from additional relationships. We’ve learned to evolve our internal sophistication as we build out exposures,” she says.
While private markets have weaker regulatory requirements around sustainability and carbon reporting, this is not a problem for Nest. “We make all the same demands on our private market managers,” she says. “It’s a requirement. In fact, our private market managers have greater direct insight into companies. Theoretically, we should be able to get better sustainability reporting.”
She notes private equity, in particular, is improving, and managers can ask their companies to make it a priority. “Managers have less leverage in private debt but it’s still getting there, they’re demanding more transparency and reporting so it’s getting better,” she says.
Controlling fees
The Value for Money framework has put pressure on fees throughout the DC pensions sector. When it began allocating to private markets, Nest decided the best way to control costs would be to allocate to evergreen funds.
“We wanted to form relationships with just a few managers, so they would see us as reliable source of capital,” she says. “Being able to offer a permanent and growing source of capital means we’ve been able to negotiate very attractive fees. They can count on us in an evergreen structure, so it’s worked extremely well for us.”
Nest has been vocal about not paying performance fees. “We don’t pay carry,” she says. “The trade-off is we can help managers scale their strategies, allowing further commercialisation. We’ve kept our fee cap tight, even when growing private markets exposure.”
Nest’s role in auto-enrolment meant it was very likely its AuM would rapidly expand, making it a highly desirable partner. “It’s getting even easier,” she says. “It’s now a proven model and managers have noticed it works very well. Everyone can see how our managers have grown and scaled businesses, so many others are interested in working with us.”
Being able to offer a permanent and growing source of capital means we’ve been able to negotiate very attractive fees.
Rachel Farrell, Nest
While Nest has allocated to private equity (PE), one notable omission from its portfolio is venture capital (VC). “VC is risky, so we would need to understand it very well, and it is also hard from a fee perspective,” says Farrell, noting Nest is always looking for innovative ways to overcome such barriers.
She says many PE managers are pricing under the assumption of the LP making a significant co-investment. “You don’t pay on the co-invest, you pay on the fund exposure. They’re looking at ways to give asset owners lower fees overall. But it’s still testing nerves.”
She notes there been some fee compression in both PE and VC – and being cash flow positive puts master trusts in a relatively strong negotiating position. “It feels that way,” she says. “Managers are having a little bit more trouble raising new funds – and maybe that makes them take note of what Nest can do.”
Farrell notes that there is widespread belief – which Nest is currently analysing – that more late-stage VC capital would benefit the UK economy. “Scale-up appears to be where there is greatest need,” she says. “UK capital at that stage would help companies grow and create jobs in the UK. Most scale-up capital comes from the US, so there is concern these companies will end up listing there and ultimate migrate jobs.”
While Nest was set up by the government, it doesn’t have any responsibility for supporting the UK economy. “There’s no obligation, no mandate,” she says. “But we are trying to give members the best outcomes, so we see improving employment, to whatever extent we can, as a benefit.”
Nest is also in the process of reviewing its UK real estate allocation. “We did a partnership for build-to-rent, as it combines a good return with solving a market need. We are now looking at other areas in UK real estate, with alignment of good investment characteristics and stock that’s needed.”
Key facts
- Total AuM: £50 billion
- Private markets allocation: c.15% (£7.5 billion)
- First allocation: 2019
- Capabilities: Small internal team of specialists, external fund managers and strategic partners inc. IFM Investors
- Current private markets: Private equity, private credit, infrastructure and timberland
- Target allocation: 30% by 2030