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Our viewpoint

Are DGFs a healthy choice?

We all know it’s healthy to have a balanced diet and that meals should comprise a mix of carbs, protein and veg, in different quantities.  The same can be said when thinking about pension scheme investment and weighing up the mix of different asset classes on offer.

Diversified Growth Funds (“DGFs”) have seen phenomenal growth in assets over the last decade, but for the first time in three years they have seen net outflows in Q3 2017. 

Are DGFs still relevant and, if so, where do they fit into the investment menu?

There is currently a massive £180bn in total invested in Sterling denominated DGFs* and many of our clients at LCP have DGF mandates.  Looking back over the last decade, DGFs have done a good job returning overall broadly in line with equity markets but with half the volatility.  

More recently returns have disappointed some investors, as they have lagged the returns available from equities, with many equity markets now at all-time highs.  Coupled with record low levels of volatility in equities – there were only eight days in 2017 where the S&P 500 index moved as much as 1%** – I have found myself asking: what is the role for DGFs?

Don’t expect equity-like returns

LCP currently has positive but moderate return expectations for DGFs.  We don’t expect them, as a group, to achieve equity-level returns over a full cycle.  Therefore, they are unlikely to be a primary growth engine in a portfolio or, put another way, the main staple of your diet.

However, given their ability to manage downside risk, I believe there is still a place for DGFs in many client portfolios:

  • Within defined benefit schemes, I believe that DGFs, offering significantly higher returns than cash, are useful as a source of liquidity to support derivative‑based strategies, such as liability-driven investments. They may also be used as a lower risk/return asset as part of the growth portfolio.
  • Within defined contribution schemes, they can be used from the mid-career phase of a lifestyle strategy onwards, where risk management becomes more of a requirement. They can also be offered as a self‑select option for particularly risk adverse investors.

The ingredients needed for a good DGF

Each investment manager’s approach is unique and offers different characteristics.  The key features investors should look for in a DGF portfolio (either through a single manager or multiple managers) are a mix of:

  • broadly diversified exposure to different ideas, particularly where the DGF can gain exposure to smaller, esoteric asset classes that are harder to access on a standalone basis;
  • manager skill ie the manager’s ability to add value by combining and adjusting the exposures to these asset classes; and
  • sufficient risk exposure to meet the return expectations.

I believe DGFs should remain on the investment menu

Investors should not expect DGFs to deliver equity-level returns over a full cycle.  Nevertheless they remain an important, if selective, building block for investment strategies, like the accompanying broccoli or peas.  After all, everybody needs their greens!

Footnotes:
*GBP shareclasses only, Camra Data, 30 September 2017
**According to Financial Times / S&P Dow Jones Indices