Pension schemes turn to diversified growth funds for higher returns and lower volatility
Clear Path Analysis
Now a well-established phenomenon, Diversified Growth Funds (DGFs) – multi-asset funds encompassing a broad selection of approaches – have seen a huge rise in popularity in recent years, with most generating equity-like returns yet with lower volatility and often performance benchmarks linked to inflation.
The second annual ‘Investing in Diversified Growth & Multi-Asset Funds’ report from Clear Path Analysis, looks at the challenges facing pension sponsors and their scheme representatives, and assesses how the investment proposition of DGFs is evolving as well as the issues and opportunities driving it forward. Opening the debate, Steven Edgley, Investment Director, Investment Solutions Group at Fidelity Worldwide Investment, chairs a discussion on the future of the DGF.
Continuing this, Miles Geldard, Manager of the Jupiter Strategic Total Return Fund (Sicav), traces the evolution of risk management to show how multiple-asset class investing can help overcome the limitations of a traditional diversified portfolio.
Geldard notes: “Diversification for protection is an old idea. Around two thousand years ago the Talmud recommended we divide our money into three parts: invest a third in land, a third in business and keep a third in reserve. This early example of a balanced portfolio is remarkably modern in conception.”
“It emphasises that the diversification of risk should take precedence over the maximisation of return. While investment risk can rarely be eliminated, investors have long since refined their techniques, enabling them to reduce the risks associated with the returns from investments.”
“What is unusual about the addition of new asset classes to a portfolio is not that they can reduce volatility, but they can also generate a pattern of rising returns, when assets remain uncorrelated. At heart this is simply a modern version of an ancient idea.”
Andrew Benton, Head of International Sales & Business Development at Baring Asset Management, comments on the recent sell-off across all risk assets which makes the argument for investing in a broad selection of assets even stronger.
Benton writes: “Increasing market volatility and heightened risk continues to challenge the developed markets, and naturally investors seek sanctuary in safe haven assets like gold, cash and government-issued bonds. However it doesn’t necessarily have to be a case of adopting an all-or-nothing investment approach to portfolio management during these challenging times.”
“Instead, a multi-asset investment approach can help deliver investors long-term equity-like returns, but with considerably less risk. We argue that the critical skill set in achieving this target couples dynamic asset allocation and a willingness to move between different asset classes at different times – ranging from equities and bonds to carefully selected alternatives such as gold and property.”
“A major challenge currently facing investors is how to best protect portfolios in an environment of rising inflationary pressures and subdued economic growth. The downturns of 2008-09 and summer 2011 reinforced the need for investors to seek managers who are able to provide a flexible approach to asset allocation in order to navigate through difficult periods and we see this trend continuing.”
Commenting on the gaining popularity of DGFs since they were first introduced Simon Chinnery, Senior Client Advisor at J. P. Morgan, encourages investors to devote more time assessing what the future holds for these highly effective investment strategies.
Chinnery said: “Increased demand has led to a proliferation of diversified growth strategies, which has left many investors facing a difficult choice when it comes to selecting the right diversified growth manager.”
“There also appears to be some confusion among investors regarding the varying return targets, benchmarks and strategies used as well as the role these funds can play in both defined benefit (DB) and defined contribution (DC) pension portfolios.”
The success of DGFs lies in their objective to produce attractive levels of long-term return, while dampening volatility and offering daily liquidity. Diversified growth funds can bring several advantages for both DC and DB pension plans.
He continues: “Because of the different strategies used by different DGFs, we are likely to see pension plans begin to diversify their diversified growth exposure.”
“Some DB pension plans are already beginning to consider taking a multi-manager approach, maintaining exposure to a range of diversified growth managers depending on the growth and liability profile of the plan.”
“DC plans are increasingly emulating the DB sector by employing two or more diversified growth strategies within a blended default option. As the sophistication of DC plans increases, some may also think about designing age-related defaults based on blended diversified growth strategies.”
Len Currie, Investment Director, UK Institutional Business at Standard Life Investments, reiterates these points: “We take an absolute return approach to multi-asset investing. Conventional asset management exploits the stock selection skills of fund managers, while multi-asset portfolios add the dynamic management of market returns from traditional asset classes. Absolute return funds go even further, adopting additional approaches that help it to remain diversified even in the most extreme market conditions.”
“In a volatile investment landscape, pension fund investors face an increasing challenge to deliver investment returns at an acceptable level of risk. As a result, taking an absolute return approach has increased in popularity as it seeks to provide positive returns whether markets are rising or falling. In this environment, the ability to diversify and still continue to generate positive investment returns is vital.”
On investing in DC schemes, Currie adds: “In order to deliver the required retirement outcomes of their members, trustees and plan sponsors are looking for new and innovative ways to generate returns and avoid volatility. In particular, they are looking for ways to navigate market, inflation and longevity risks to ensure that scheme members achieve their expected retirement outcome.”
Chinnery expands on where he sees the future for diversified growth: “We’d expect to see a move to diversify away from equities into assets that can give adequate inflation protection while also providing some protection during periods of stock market volatility. This would include widening the investment scope to include a greater exposure to real assets and other inflation hedging assets, including greater use of alternatives.”
“Such inflation sensitive investments may include index linked bonds, CPI swaps, real estate investment trusts, commodities, natural resources and infrastructure. Also, unconstrained bond strategies (e.g. strategic bond funds) can provide a higher yield and cushion returns against inflation while also providing significant diversification benefits.”
Reflecting on developments to date and considering what’s ahead Stephen Budge, DC Investment Lead at KPMG LLP, concludes: “Not so long ago, the default investment design for the average DC scheme was almost as straight forward as investing 100% in equity and then moving to a mix of bonds and cash as retirement approached – well, almost.”
“Over the last few of years we have witnessed a greater opportunity for diversification in DC scheme portfolios along with more focus on improving the design with guidance from government, pressure groups and views from a wealth of other industry figures. With the onset of auto-enrolment, schemes should review their default to make sure it is appropriate for members who may not even be aware that they are in a pension scheme.”
“The future for DGFs and absolute return funds in DC scheme design, and in particular, structured portfolios and strategies is bright. We have no doubt that we will see increasing use of these types of funds and the newer ‘passive’ versions called Diversified Beta Funds (‘DBFs’) over time. The days of 100% equity in the growth phase of a default lifestyle strategy are numbered!”
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