A roadmap to a resilient retirement

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.

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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.

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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.

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

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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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