A sensible investment strategy is really just about not putting all your eggs in one basket

The investment world has been a topsy-turvy place in recent years.

The hunt for yield and limited – or controlled – volatility has boosted the popularity of diversified growth funds (DGFs) .

DGFs

The term DGF itself has at times been contentious, as its does-what-it-says-on-the-tin moniker hides the potential for complex arrangements.

There is no established definition for a DGF, so it therefore covers a multitude of investment approaches. These have developed from traditional balanced funds through to multi-asset instruments.

The approach started as a means of delivering equity-like performance with considerably less volatility.

This required a broader set of asset classes than simply equities and bonds and have included a number of alternative strategies, including property and commodities.

With DC members footing the bill, schemes needed diversification without excessive volatility

All this could be achieved through a single pooled investment structure, so schemes didn’t have to bank on a single asset class to deliver growth over the long term.

They still aim to achieve this equity-like performance with reduced volatility, but there has been a proliferation of products in the past few years, and they fast became a staple of the return-seeking assets in some defined benefit (DB) schemes.

They also, increasingly, became recognised as a component of the default fund or lifestyle option of defined  contribution (DC) schemes. After all, with DC members footing the bill, there wasn’t anywhere else they could get such diversification without excessive volatility.

However, the charge cap of 75 basis points (bps) on default arrangements led many DC schemes to row back from the use of DGFs, with their fees near the charge cap.

The charge cap led many DC schemes to row back from the use of DGFs

As a result – though some of the differences can be due to investment styles – more products were offered that purported to meet both the wish for diversification and the limitations imposed by the charge cap.

These ‘DGF-lite’ products were often heavily equity-biased, meaning there are three distinct categories of DGF available to schemes, though there can be vast differences between two funds in one category.

They have been broadly defined by the Pension and Lifetime Savings Association, among others, as:

  • Strategic DGF/diversified beta - largely passive with a static asset allocation
  • Dynamic - using both strategic and tactical asset allocation with greater risk management
  • Absolute return - aim to deliver a target return, usually quantified in terms of outperformance of Libor or cash. This latter group is the most actively managed.

It is really only the early adopters that have had long enough to find out whether DGFs really have done exactly what it says on the tin.

Research from Willis Towers Watson shows that overall, DGFs have not really achieved what schemes required of them.

At times, they have shown themselves to be highly correlated to other asset classes and overall they have delivered the equivalent of a 60/40 equity/ bond fund.

The number of trust-based DC schemes offering DGFs has increased from 72% to 93%.

Even if they might have performed better, they have done a job under difficult circumstances. Where else would schemes have accessed such diverse exposures – even if that diversification has been shown to be limited at times?

he number of trust-based DC schemes offering DGFs has increased from 72% to 93%.

Well, you can always get a bespoke strategy - if you are happy to bear the cost, or comfortable with a fiduciary manager/outsourced chief investment officer approach.

The appetite for alternatives is going up, having increased from 4% in 1997 to 24% among investors in the US, UK, Australia, Canada, Netherlands, Switzerland and Japan, according to the Willis Towers Watson Global Alternatives Survey 2016.

This will only continue, as pension schemes acknowledge the essential role that alternative assets – such as those listed in this table below - have played in delivering long-term growth in DB schemes.

DGF table

While difficulties remain for the inclusion of alternatives in DC plans, so DGFs – a bolt-on, pooled arrangement – will surely remain popular for the foreseeable future.